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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-27150
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PATHOGENESIS CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 91-1542150
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
201 Elliott Avenue West, Seattle, Washington 98119
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (206) 467-8100
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value per share
Preferred Stock Purchase Rights (currently traded with Common Stock)
(Title of Each Class)
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Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock of the Registrant held by
stockholders who were not affiliates (as defined by regulations of the
Securities and Exchange Commission) of the Registrant was approximately
$393,223,924 on March 17, 2000 (based on the closing price quoted on the Nasdaq
National Market on March 17, 2000, as reported by The Wall Street Journal). On
March 17, 2000, the Registrant had issued and outstanding an aggregate of
16,506,407 shares of common stock.
Documents Incorporated by Reference
Those portions of the Registrant's proxy statement to be filed pursuant to
Regulation 14A for the annual meeting of stockholders to be held on May 31,
2000, described in Part III hereof, are incorporated by reference in this
report.
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PART I
In addition to historical information, this annual report on Form 10-K
contains forward-looking statements. You may identify these forward-looking
statements by the use of such words as "believe," "anticipate," "expect," "plan"
and "intend." Since these statements are based on factors that involve risks and
uncertainties, they do not necessarily indicate what our actual future results
will be. Factors that could cause or contribute to differences between our
actual results and the results expressed or implied by the forward-looking
statements include, but are not limited to, those discussed in "Item 1.
Business" and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" of this Form 10-K, and in Exhibit 99.1 to
this Form 10-K. These factors include, but are not limited to, uncertainties
related to the fact that PathoGenesis only began commercial operations in 1998,
its dependence on TOBI, the degree of penetration of its markets and frequency
of TOBI's use by patients, risks associated with marketing TOBI in international
markets, third party reimbursement and product pricing, seasonal impacts on
hospitalizations or exacerbations experienced by patients, variability in
wholesaler ordering patterns, drug development and clinical trials, uncertain
outcome of the U.S. and international drug approval process, competition and
alternative therapies. We cannot assure you that TOBI - which is currently our
only product - will penetrate markets as planned, that our development of TOBI
for other uses will succeed or occur within anticipated time frames, or that we
will develop any of our other drug candidates successfully.
Item 1. Business
Summary
PathoGenesis Corporation develops and markets drugs to treat infectious
diseases - particularly serious lung infections - where there is a significant
need for improved therapy.
Our drug TOBI(R) (tobramycin solution for inhalation) was initially tested
and approved for cystic fibrosis (CF) patients with Pseudomonas aeruginosa lung
infections. TOBI has been on the market in the U.S. since January 1998. Sales
are growing as market penetration of the drug increases in the U.S. and other
countries where TOBI has been approved for sale. According to industry data,
pseudomonal bacteria infect the lungs of about 60% of the 70,000 people
worldwide with CF. Our market surveys indicate that TOBI also is being used by
non-CF patients with similar respiratory infections.
In 2000, PathoGenesis intends to make significant investments in research
and development (R&D) to enhance our company's future sales potential, both in
CF and in new markets. Our planned R&D programs include:
. conducting or co-sponsoring clinical trials of TOBI in a variety of groups,
including CF, bronchiectasis, ventilator-associated pneumonia (VAP) and
lung transplant patients.
. pursuing development and registration of a product combining TOBI and the
portable AeroDose Inhaler, a hand-held, portable delivery device made by
AeroGen, Inc. Our goal is to deliver TOBI to the lungs in 5-10 minutes or
less versus the current 15-20 minutes.
. beginning Phase I clinical trials of PA-1806 for inhalation. This drug
candidate was licensed from Bristol-Myers Squibb and has a different
mechanism of action from TOBI, potentially allowing it to be used for
treating serious lung infections in combination with TOBI or in alternating
cycles.
. initiating preclinical development of at least one additional antibiotic
for inhalation to address broader respiratory infection markets.
. collaborating with Chiron Corp. to develop new antibiotics with new
mechanisms of action to better address serious medical needs, particularly
concerns about drug resistance. The collaboration was formed to combine our
strengths in identifying novel antibiotic targets, assays and drug
development and knowledge of the P. aeruginosa genome (DNA or genetic code)
with Chiron's strong combinatorial chemistry library and expertise in high-
throughput screening.
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PathoGenesis was incorporated in 1991 as a Delaware corporation. Our
executive offices are located at 201 Elliott Avenue West, Seattle, Washington
98119. Our telephone number is (206) 467-8100.
Overview: Inhaled Drug Development Program
Our goal is to develop drug candidates that can provide significant benefit
to people with difficult-to-treat lung infections, including people with cystic
fibrosis, bronchiectasis, ventilator-associated pneumonia and lung transplants.
Many of these serious infections are caused by P. aeruginosa, a common gram-
negative pathogen. In 1999, we completed our analysis of P. aeruginosa's genetic
structure in collaboration with the University of Washington Genome Center and
the Cystic Fibrosis Foundation. Our first drug, TOBI, is an inhaled antibiotic
that was developed to treat pseudomonal lung infections.
In 1993, we began researching inhaled antibiotics in order to deliver drugs
directly to the site of infection in the lungs, rather than systemically through
the blood. Our researchers believed a much larger dose could be safely delivered
to the lungs if systemic absorption could be limited. Antibiotics administered
intravenously or orally (in tablet or capsule form) must travel through the
bloodstream and lung tissue to reach the site of most lung infections. In the
case of intravenous tobramycin, higher levels of drug in the bloodstream lead to
adverse side effects - hearing loss and kidney damage.
TOBI is the first inhaled antibiotic solution to be approved by the Food
and Drug Administration. To achieve that, we had to develop a preservative-free
sterile formulation of tobramycin for inhalation, find a suitable nebulizer
(device used to produce an antibiotic aerosol mist), conduct multiple clinical
trials and gain regulatory approval of TOBI. Before our Phase III clinical
trials of TOBI began in 1995, we chose the Pari LC Plus nebulizer for use with
TOBI because it could efficiently deliver the correct particle size of drug to
the lungs. Antibiotic particles that are too large can get caught in the back of
the throat and the upper airways. Particles that are too small are deposited
predominantly in the alveoli (air sacs), which increases systemic absorption and
does not allow the drug to reach the site of infection in the airways of the
lung.
Since we began developing TOBI in 1993, drug delivery companies have
invented new generations of nebulizers and dry powder delivery devices which are
hand-held, portable and do not require the use of an electrically powered air
compressor. One such device is the AeroDose Inhaler, made by AeroGen, Inc. We
are working with AeroGen to develop and register a product combining TOBI and a
customized version of the AeroDose Inhaler. Our goal is to improve convenience
and deliver TOBI to the lungs in 5-10 minutes or less, versus the current 15-20
minutes.
In addition to TOBI, we are conducting preclinical research on PA-1806, a
novel, patented drug candidate that was licensed from Bristol-Myers Squibb in
1998. In the laboratory, PA-1806 has demonstrated activity against gram-negative
lung pathogens.
This year, we intend to initiate a preclinical program on at least one
other antibiotic for inhalation. Our objective is to address broader respiratory
infection markets with a drug candidate that has demonstrated activity against
both gram-negative and gram-positive lung pathogens.
TOBI and the Cystic Fibrosis Market
TOBI is a stable, premixed, proprietary formulation of the antibiotic
tobramycin for delivery by inhalation using a nebulizer. Each ready-to-use
ampule of TOBI contains 300 milligrams of tobramycin in a 5 milliliter solution.
TOBI is administered using a Pari LC Plus reusable nebulizer and a DeVilbiss
Pulmo-Aide air compressor. It is inhaled in two daily sessions requiring 15-20
minutes per session. The TOBI treatment regimen consists of repeated cycles of
28 days on drug, followed by 28 days off drug. This regimen was proven safe and
effective in clinical trials.
Tobramycin is a fermentation product isolated from Streptomyces tenebrarius
in 1967. It is a water-soluble compound belonging to the group of antibiotics
called aminoglycosides. Like other aminoglycosides, tobramycin inhibits
bacterial protein synthesis and is most active against gram-negative bacteria.
Compared with other
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aminoglycosides, tobramycin is more active against P. aeruginosa by at least
two-to four-fold and is generally less toxic. Intravenous tobramycin has been
approved for marketing for more than 20 years.
TOBI has been designated an orphan drug by the U.S. Food and Drug
Administration (FDA), which gives us seven years of marketing exclusivity in the
U.S. from the time of TOBI's approval in late 1997. TOBI also is covered by
formulation patents in various countries. PathoGenesis has an exclusive
worldwide license from Children's Hospital and Medical Center in Seattle (based
on Phase II research done there and in other clinics) for patents, research and
technology relating to the use of an aerosol tobramycin solution or any other
aerosol aminoglycoside solution for the treatment of bronchopulmonary
infections.
Cystic Fibrosis Lung Infections
Cystic fibrosis is the most common life-shortening inherited disease in the
U.S., affecting about 30,000 Americans. According to the Cystic Fibrosis
Foundation, CF is diagnosed in one of every 3,300 newborns in the U.S. The
median survival age is about 32 years. About two-thirds of CF patients in the
U.S. are treated at more than 110 centers accredited by the Cystic Fibrosis
Foundation.
About 40,000 CF patients live outside the U.S. The disease is most
prevalent in Europe, Canada, Australia and other countries where Caucasians have
immigrated, because CF is primarily a Caucasian genetic disease. Although the
incidence of CF in those countries is similar to the U.S., life expectancy can
vary from country to country depending on the caliber of care. Most countries
have CF centers comparable to those in the U.S.
CF is characterized by the production of unusually thick, sticky mucus that
obstructs the airways of the lungs, the bronchial tubes and bronchioles. Early
in life, CF patients typically have bacterial infections comparable to other
children. Although the majority of their early lung infections are treated
effectively, the accumulation of mucus in the lungs usually leads to life-long
infections. This results in gradual destruction of lung tissue, and eventually,
respiratory failure. P. aeruginosa is the dominant bacterium and infects the
lungs of about 60% of all people with CF in the U.S. Infection with pseudomonal
bacteria is increasingly likely as the patient ages. Furthermore, P. aeruginosa
is rarely if ever permanently eradicated after antibiotic treatment.
An estimated 90% of all illnesses associated with CF are related to the
respiratory system. Periodic flare-ups of pseudomonal infection can cause life-
threatening episodes and hospitalization, which increases treatment costs,
exposes the patient to potential hospital-acquired infections, and disrupts
education and family life. For more than 20 years, the standard treatment for
those flare-ups was intravenous tobramycin, typically for periods of 10-14 days.
However, cumulative systemic exposure to intravenous tobramycin increases the
risk of adverse side effects, such as significant kidney damage and hearing
loss.
TOBI for Cystic Fibrosis Lung Infections
As an antibiotic specifically formulated for inhalation, TOBI is delivered
directly to the lungs where the infection resides. The drug is formulated to
minimize its absorption into the bloodstream, thereby reducing the risk of
adverse effects. On average, 100-fold greater concentrations of tobramycin can
be delivered to the actual site of infection by directly depositing the
antibiotic on the airway lining as compared with intravenous delivery. Treatment
of pseudomonal infection using TOBI would be expected to begin at the first
detection of pseudomonal bacteria and may continue throughout the patient's
lifetime. We believe the market for TOBI is significant and growing. Industry
data indicate that pseudomonal bacteria infect the lungs of about 60% of the
70,000 people worldwide with CF. Market growth may occur as new patients are
diagnosed and improved therapy extends the lives of patients.
In an article on TOBI published in The New England Journal of Medicine,
Jan. 7, 1999, the authors wrote: "Our study shows that long-term, intermittent
administration of inhaled tobramycin in conjunction with standard therapy for CF
improves pulmonary function, decreases the density of P. aeruginosa in
expectorated sputum, and reduces the need for intravenous antipseudomonal
antibiotics and hospitalization." The article described the Phase III clinical
trials of TOBI, which comprised the largest study of inhaled antibiotics to
date.
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All patients who completed the six-month Phase III clinical trials were
eligible for a series of follow-on studies, allowing them to continue inhaling
TOBI in repeated cycles of 28 days on drug, 28 days off drug for up to two years
(96 weeks). Among the results announced in 1999:
. Patients breathe better. At the end of the last on-drug cycle (after 92
weeks), average lung function remained nearly 5% above baseline (at week
0) -a significant achievement considering that most CF patients typically
lose lung function over that same period of time.
Adolescents (ages 13 to 17) had the largest improvement in their ability to
breathe when compared with the other age groups, showing a treatment effect
of about 14% in lung function improvement above baseline at the end of the
last on-drug cycle. The typical teenager loses lung function more rapidly
than an older or younger person with CF.
. Patients live better. In every season, TOBI reduced the number of days
patients were hospitalized. TOBI produced the largest effect during the
fall season, the time of year when CF patients are most frequently
hospitalized for exacerbations or flare-ups of pulmonary symptoms. After
two years, study results showed a 62% reduction in the number of days
patients on TOBI (versus placebo) were hospitalized in October, November
and December.
. Patients enjoy better nutritional status. Teenagers in the TOBI clinical
trial dramatically demonstrated the benefits of improved infection control.
After six months of TOBI therapy, adolescent patients had a mean weight
gain of about five pounds, while placebo patients only gained about two
pounds. After 18 months of TOBI therapy, adolescent patients had a mean
weight gain of nearly 10 pounds above baseline. No weight differential was
seen in other age groups when comparing the TOBI and placebo groups. Weight
gain is an important indicator of nutritional status and is associated with
improved prognosis in CF patients.
. TOBI was shown to be safe for long-term treatment. In the six-month
placebo-controlled portion of the study, voice alteration (e.g.,
hoarseness) and tinnitus (ringing in the ears) were the only adverse
experiences reported by significantly more TOBI patients than patients
receiving placebo plus usual care. In the two-year follow-on studies, most
adverse events declined with increased TOBI exposure.
The emergence of drug-resistant bacteria is a concern with long-term
administration of any antibiotic. However, intravenous tobramycin therapy for
acute flare-ups of pseudomonal infection in CF patients is usually efficacious,
even though resistant pseudomonal bacteria are frequently found. Treatment for
six months with TOBI in the clinical trials did not affect the susceptibility of
the majority of P. aeruginosa isolates tested. However, microbiological measures
of increased drug resistance were noted in some patients. The relationship of in
vitro (laboratory) susceptibility test results and clinical outcome with TOBI
therapy has not been established. In fact, the 24-month data on TOBI show
positive clinical responses in those few patients with pseudomonal bacteria
considered resistant by traditional intravenous measures.
Broadening the CF Market for TOBI
The two-year clinical trial of TOBI tested our drug in patients with severe
or moderate impairment of lung function, defined as lung function of 25% to 75%
of normal levels. Although TOBI has been approved for use by all CF patients
with P. aeruginosa lung infections, without limitations based on lung function
level, we believe that U.S. physicians to date have been most likely to
prescribe TOBI to patients with moderate to severe lung function impairment. In
addition, our market research indicates that those are the patients most likely
to use TOBI as approved versus for acute or episodic treatment of pulmonary
exacerbations. The approved regimen (twice a day for 28 days on drug, 28 days
off drug) would require U.S. patients to purchase about six cartons of TOBI per
year; a carton contains a 28-day supply or 56 ampules (vials) of TOBI. Acute or
episodic use of TOBI might typically require as little as one carton a year or
as many as 3-4 cartons.
To further expand the CF market for TOBI, we intend to continue our
education and outreach programs for physicians, other CF care professionals and
patients. In addition, we plan to conduct or co-sponsor additional clinical
trials. For example, this year we plan to conduct a clinical trial in CF
patients age six through 15 with mild pulmonary symptoms. Our goal is to verify
in this subset of CF patients that chronic intermittent use of TOBI will
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improve pulmonary function versus the decline seen with standard care. See
"Sales and Marketing." We also expect to announce new TOBI data in 2000,
including results of a clinical trial in 22 of the U.K.'s 44 CF centers.
Other Potential Markets for TOBI
Our market surveys reveal that TOBI is being used by non-CF patients with
serious and/or chronic respiratory infections. We believe that the
pulmonologists who treat CF patients are the most likely to prescribe TOBI for
other patients with similar respiratory infections. In 2000, PathoGenesis
intends to conduct or co-sponsor a number of clinical trials of TOBI in a number
of these patient groups, including bronchiectasis, ventilator-associated
pneumonia and lung transplant patients.
Bronchiectasis
Bronchiectasis is an abnormal enlargement of the bronchi that induces or
follows chronic infection of the airways. The airways frequently contain large
amounts of thick, pus-containing mucus, causing patients to experience incessant
coughing and difficulty in breathing. Often, many of the more distant airways
are blocked by secretions or completely destroyed and replaced by fibrous
tissue. Inflammation is caused by persistent bacterial infection in the lungs'
air passages, often with P. aeruginosa. In turn, that inflammation leads to
progressive lung damage. Damage may occur in both lungs or only one lung.
Although a small percentage of patients have localized damage that can be
treated successfully through surgery, most patients are treated with oral or
intravenous antibiotics, including macrolides, quinolones and aminoglycosides.
Severely affected patients may require multiple hospitalizations to treat
complications of the condition.
Causes of bronchiectasis include viral or bacterial pneumonia,
tuberculosis, primary ciliary disorders, exposure to toxic substances and
AIDS/HIV. As an anatomical condition, bronchiectasis can be definitively
diagnosed through CT scans, while chronic bronchitis is primarily diagnosed from
symptoms. Although the clinical manifestations of bronchiectasis are similar to
CF lung disease, bronchiectasis patients are usually older than age 50. The
condition affects 70,000 to 100,000 people in the U.S. alone, based on our
market studies and hospital discharge records. However, we believe
bronchiectasis is significantly underdiagnosed, in part, because symptoms and
treatments are similar for bronchiectasis and severe chronic bronchitis.
The percentage of bronchiectasis patients infected with P. aeruginosa can
vary significantly by geography and practice setting (hospital versus office-
based practices). Published studies indicate pseudomonal infections can occur in
as many as 25% to 50% of bronchiectasis patients in hospital settings.
Bronchiectasis patients with moderate to severe disease are the most likely to
be infected with P. aeruginosa. Other bacteria that typically infect these
patients include Haemophilus influenzae, Streptococcus pneumoniae and
Staphylococcus aureus.
Ventilator-Associated Pneumonia
Our market studies indicate that annually, 150,000 to 230,000 patients on
ventilators in the U.S. develop ventilator-associated pneumonia. The risk of VAP
increases the longer the patient is on a ventilator. Pneumonia may be caused by
bacterial contamination of the ventilator circuit and respiratory therapy
equipment. The presence of invasive medical devices, such as tracheotomy tubes,
is another important contributor. Mortality in VAP patients is very high. VAP
also contributes to longer hospital stays and increased hospital costs.
Most VAP infections are due to gram-negative bacteria, particularly those
occurring after 72 hours of mechanical ventilation. Bacteria associated with VAP
include P. aeruginosa and H. influenzae. Standard treatment is with a
combination of antibiotics, often including an intravenous aminoglycoside, such
as tobramycin.
Lung Transplants
An estimated 7,500 people in the U.S. have had lung transplants. People
with CF, idiopathic pulmonary fibrosis (IPF) and chronic obstructive pulmonary
disease (COPD) are among the patients who receive lung transplants or heart-lung
transplants. Those patients take medications to prevent tissue rejection, which
also depress the body's natural defenses against infection and create a greater
risk of serious lung infections. Furthermore, some patients continue to harbor
pseudomonal infections in their sinuses, increasing their risk of re-developing
chronic
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pseudomonal lung infections. The rate of infection among lung transplant
recipients is several times higher than the infection rate for recipients of
other organs, most likely related to the exposure of the lung graft to the
outside environment. The median survival of lung transplant patients is 3.8
years, with about 30% of deaths related to infection, according to the
International Society for Heart and Lung Transplants.
TOBI: The Next Generation
Cystic fibrosis patients generally take a number of medications and other
treatments, even when they are feeling relatively well. A typical regimen
requires the patient to spend up to two hours in the morning and another 1-1/2
hours in the evening taking inhaled medications, oral
medications/enzymes/vitamins and chest physiotherapy, including the time needed
to clean nebulizers and other equipment between uses. Our market studies show
that the total time required for these treatments can have a dramatic impact on
the patient's compliance with the recommended TOBI treatment regimen and on the
physician's assessment of a patient's likelihood of compliance.
Furthermore, bronchiectasis and other patients outside the CF market may
not be familiar with nebulizers and electrically powered air compressors and may
not be willing or able to take TOBI using the current delivery technology. As a
result, we believe the market for TOBI could be broadened significantly if we
can find a way to deliver an effective dose of TOBI more quickly by using a
hand-held, portable delivery device. Since we began developing TOBI in the mid-
1990s, drug delivery companies have invented new generations of hand-held
nebulizers and dry powder delivery devices that do not require the use of an air
compressor and could be suitable for inhaled antibiotics.
One such hand-held, portable device is the AeroDose Inhaler, made by
AeroGen, Inc. We are collaborating with AeroGen on developing and registering a
product combining TOBI and a customized version of the AeroDose Inhaler. We
intend to begin a Phase I clinical trial of TOBI using the AeroGen device in the
second quarter of 2000. Our goal is to deliver TOBI to the lungs in 5-10 minutes
or less, versus the current 15-20 minutes.
Follow-On Drug Candidates to TOBI
We are developing other drug candidates in our planned portfolio of
antibiotics. The drug candidates would have different mechanisms of action from
each other and from TOBI, which could provide physicians with alternative or
alternating treatments.
PA-1806
About two-thirds of all antibiotics are beta-lactams, including amoxicillin
and ceftazidime. Beta-lactams work by interfering with the synthesis of the
bacterial cell wall, killing the pathogen rather than simply slowing its growth.
The monobactams are a subset of the beta-lactams and share a common core
structure (the beta-lactam ring) in their chemical makeup.
PA-1806 is a patented new chemical entity in the monobactam class of
antibiotics that initially was synthesized by Bristol-Myers Squibb. In 1998,
PathoGenesis obtained an exclusive worldwide license from Bristol-Myers Squibb
for the aerosol use of PA-1806. A patent on the drug candidate (originally BMS-
180680) was issued in 1994 and will expire in 2011. We intend to begin Phase I
clinical trials of PA-1806 for inhalation in 2000. PA-1806 has a different
mechanism of action from TOBI, potentially allowing it to be used for treating
serious lung infections in combination with TOBI or in alternating cycles.
PA-1806's spectrum of activity was evaluated in various studies conducted
by Bristol-Myers Squibb. In in vitro studies, PA-1806 was more active than
antibiotics currently in use against P. aeruginosa. In addition, PA-1806 was
active against Burkholderia cepacia and Stenotrophomonas maltophilia, pathogens
that are particularly problematic for people with CF. PA-1806 also has shown
efficacy against P. aeruginosa in animal models, including systemic and lung
infection models.
In Phase I clinical trials, Bristol-Myers Squibb tested PA-1806 in
intravenous form in healthy volunteers. In intravenous form, the drug candidate
had an acceptable safety profile at blood levels above those anticipated to
reach circulation by aerosol delivery. However, the drug candidate's systemic
half-life in humans was less than one
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hour, making it unsuitable for intravenous administration. On the other hand,
rapid systemic clearance is not an issue in topical aerosol delivery, and may in
fact be beneficial.
A Third, Broad-Spectrum Inhaled Antibiotic
In early 2000, we announced plans to initiate preclinical development of at
least one other antibiotic for inhalation to address broader respiratory
infection markets. The ideal drug candidate would target both gram-negative and
gram-positive bacteria that cause serious infections, complementing TOBI and PA-
1806, which show activity primarily against gram-negative bacteria. Ideally,
this third drug candidate could be administered in five minutes or less using a
hand-held, portable drug delivery device. We consider a broad spectrum of
activity, speed of delivery and convenience to be important factors in treating
a wider spectrum of patients who have been diagnosed with serious or chronic
lung infections.
Research and Development
We focus our research and development on drug candidates with potentially
unique therapeutic profiles, as well as those we believe we can develop
relatively quickly. We seek to shorten drug discovery and development time by
involving our clinical and regulatory personnel in the early stages of drug
discovery and development. This allows us to choose drug candidates that are of
significant interest to physicians and regulators and that have readily
measurable effects in clinical trials. We intend to focus on drug candidates we
believe we can develop through our own resources, although we may also sell,
license, joint venture or otherwise collaborate where we determine such an
approach is preferable.
Our expertise includes functional genomics and molecular target discovery,
assay development for compound screening, technology and informatics to
accelerate drug discovery, medicinal chemistry, compound evaluation in animal
infection models, and preclinical development capabilities. In addition, we have
developed specialized proficiency in the drug mechanisms of action and
resistance, inhaled drug delivery, surrogate markers and assays for clinical
trials, and clinical microbiology. We spent approximately $30.0 million, $33.0
million and $28.0 million on research and development of proposed drug
candidates in 1999, 1998 and 1997, respectively. The amount for 1998 includes
the $4.0 million initial fee to license PA-1806.
In 1999, PathoGenesis, the Cystic Fibrosis Foundation and the University of
Washington Genome Center completed a two-year genomic research project on the
genetic makeup of P. aeruginosa, a bacterium that affects CF, burn and cancer
patients. This is the largest bacterial genome to be analyzed to date. Greater
knowledge of the bacterial genome has provided new insights into how P.
aeruginosa causes infection and defends itself against antibiotics. We are using
our P. aeruginosa database in molecular targeting by identifying and validating
a number of essential molecular mechanisms which are shared by P. aeruginosa and
other bacteria and that are potential targets for drug activity. In addition, we
may seek to patent certain gene sequences that may help us develop and test drug
candidates. The genetic data derived from this Pseudomonas Genome Project are
published on the Internet at www.pseudomonas.com. From that site, researchers
around the world can download gene sequences to their own computers or use
resident software to search for similarities between a given gene and the
sequences contained in the P. aeruginosa database.
In early 2000, we announced a collaboration with Chiron Corp. Our joint
goal is to develop new antibiotics with new mechanisms of action to better
address serious medical needs, such as concerns about drug resistance. The
collaboration seeks to combine our strengths in identifying novel antibiotic
targets, assays and drug development and knowledge of the P. aeruginosa genome
with Chiron's strong combinatorial chemistry library and expertise in high-
throughput screening. Many of the antibacterial targets PathoGenesis has
identified to date are based on known essential biological processes. Knowledge
of those targets and of the relevant biological process allows the PathoGenesis-
Chiron research team to design and synthesize compounds that will inhibit,
interfere with, or block one or more essential functions in bacteria without
interfering with the function of human genes. Combinatorial chemistry allows us
to prepare vast numbers of compounds for screening, thereby increasing our
opportunities to discover novel antibiotics. Those compounds may be formulated
for oral, intravenous or inhaled administration.
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Manufacturing
We currently do not intend to establish internal manufacturing
capabilities. Instead, we have entered into contracts with third parties for the
production and packaging of TOBI. Contract manufacturing is monitored by our
manufacturing and distribution support operation in Annandale, New Jersey, which
had 22 employees as of year-end 1999. All manufacturing facilities used by
PathoGenesis are subject to inspection by the FDA or regulatory authorities in
other countries.
We obtain bulk powdered tobramycin from two of the principal worldwide
suppliers of the drug, and anticipate that either one of those suppliers alone
will be able to supply sufficient quantities to meet our current needs. TOBI is
formulated and packaged at a U.S. facility that also packages other drugs for
inhalation for other pharmaceutical companies. The powdered tobramycin is mixed
with water and excipients, then injected into plastic ampules using a form-fill-
seal technology in a sterile environment. Each ampule has a snap-top access
port, simplifying the action of delivering TOBI directly into a nebulizer for
inhalation. Other contract manufacturers handle final packaging of the ampules
into aluminum foil pouches and cartons.
Based upon our Phase III clinical trials of TOBI, we designated the Pari LC
Plus nebulizer to be used in TOBI treatments. This nebulizer is manufactured and
distributed in the U.S. by Pari Corporation of Germany. The nebulizer has a
useful life of about six months and costs about $15 U.S. at retail. Our research
shows that this nebulizer efficiently aerosolizes the TOBI solution and delivers
the optimal drug particle size to the lung airways, minimizing the amount of
drug that is absorbed systemically or coughed out. An electrically powered air
compressor also is required for TOBI treatments. CF patients may use nebulizers
and compressors for other types of inhaled treatments as well.
We are investigating the commercial feasibility of delivering TOBI with new
generation delivery devices, and may in the ordinary course enter into related
arrangements with third parties.
Sales and Marketing
Cystic fibrosis is a focused market segment comprised of a small group of
physicians and treating institutions in the U.S. and abroad. Many of those
pulmonologists also treat patients with bronchiectasis, ventilator-associated
pneumonia, lung transplants and related conditions.
We had a U.S. sales force of 30 at year-end 1999. In the U.S., about two-
thirds of the 30,000 CF patients are treated by institutions or physicians
associated with about 110 CF care centers sponsored by the Cystic Fibrosis
Foundation. We have identified about 2,000 pulmonologists at those centers and
at office-based practices who care for patients with CF and related conditions
and who we believe would be the most likely to prescribe TOBI. Although TOBI has
been approved for use by all CF patients with P. aeruginosa lung infections,
without limitations based on lung function level, we believe that its usage to
date has been primarily in CF patients with moderate to severe lung function
impairment. In addition, these are the patients most likely to use TOBI as
approved (28 days on drug, 28 days off drug) versus for acute or episodic
treatment of pulmonary exacerbations. In 1999, we implemented a number of
education and outreach programs to help disseminate the positive results of our
TOBI studies, including the benefits of prescribing TOBI to younger patients
(particularly adolescents) and of using the drug in chronic intermittent cycles.
We expect to continue those marketing efforts in 2000.
In the U.S., PathoGenesis sells TOBI to drug wholesalers and mail order
pharmacies. In 1999, sales to the three largest wholesale distributors accounted
for 64% of total sales. Pharmacies that sell TOBI accept assignment of benefits
and help patients request reimbursement from third party payors. TOBI has
achieved high reimbursement levels from third party payors, including private
insurance plans and Medicaid, which covers about 20% of CF patients. Our
revenues per carton of TOBI for patients covered by Medicaid are less than our
revenues per carton for other patients. If government and third-party payors do
not provide adequate coverage and reimbursement for TOBI, its market acceptance
would likely decline.
Because TOBI has been on the market only since January 1998, we do not know
with certainty how sales may be affected by a number of factors and whether such
factors are sporadic, cyclical or have determinable trends. These factors
include: the seasonality arising from business cycles, weather, geographic
factors, cold and flu outbreaks, the impact of hospitalization or exacerbations
experienced by CF patients, compliance with chronic therapy (28 days on drug, 28
days off drug), physician and patient concerns about potential bacterial
resistance to TOBI, insurance reimbursement factors, variability in ordering
patterns by drug wholesalers, the effect of price
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increases and changes in credit terms, and the approval, availability, efficacy
and popularity of alternative treatments. The interplay of those factors may
cause fluctuations in quarter-to-quarter sales. In addition, the effect those
factors may have on sales is likely to change as TOBI sales increase and our
drug is introduced in other countries. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
In the second quarter of 1999, we received approval to market TOBI in
Canada, where there are about 3,500 CF patients, and Argentina, which has about
400 CF patients. We have a direct sales force of four in Canada and are selling
TOBI through a distributor in Argentina. Those countries have CF centers
comparable to those in the U.S.
In the fourth quarter of 1999, we received approval to market TOBI in the
U.K., where there are about 6,500 CF patients, and Israel, where there are about
400 CF patients. We have a direct sales force of four in the U.K. and are
selling TOBI through a distributor in Israel. The U.K. is the lead country for
seeking regulatory approval of TOBI in the rest of the European Union through
the mutual recognition process. There are about 20,500 CF patients in those
other European Union countries, which generally have CF centers comparable to
those in the U.S. In anticipation of TOBI's eventual approval elsewhere in
Europe, we have opened offices in France and the Netherlands and announced
several exclusive distribution arrangements in various other countries for the
sale and distribution of TOBI.
In 1999, we completed a 28-day open-label, randomized clinical trial of 120
cystic fibrosis patients at 22 CF centers in the U.K. and Ireland. That was the
largest study of nebulized antibiotics conducted in Europe to date. Although the
study was not required for regulatory approval, it provided European clinicians
experience with TOBI in their patients, as well as valuable data for our
marketing efforts in Europe. Study results are scheduled to be announced at the
24th European Cystic Fibrosis Conference in June 2000.
In the first quarter of 2000, we received approval to market TOBI in
Australia, where there are about 2,500 CF patients. We are selling TOBI through
a distributor in Australia, where TOBI is one of the first drugs to be
designated as an orphan drug.
Regulatory approvals do not necessarily indicate pricing or reimbursement
approvals.
Licenses and Other Agreements
We have licensed from Children's Hospital and Medical Center in Seattle
exclusive worldwide rights to patents, research and technology relating to the
use of an aerosolized tobramycin solution or any other aerosolized
aminoglycoside solution for the treatment of bronchopulmonary infections.
PathoGenesis pays a royalty under the license based on net sales. The licensing
agreement continues in effect until the expiration of any patent rights under
the license, and may be terminated earlier upon a material breach by either
party. In 1998, we purchased all rights in TOBI owned by the Cystic Fibrosis
Foundation under a similar license for $16.0 million.
In 1998, PathoGenesis obtained exclusive worldwide rights from Bristol-
Myers Squibb to PA-1806, a patented chemical compound in the monobactam class of
antibiotics. Those rights cover the aerosolized, non-systemic administration of
PA-1806 for the treatment or prophylaxis of respiratory tract infectious
diseases. We agreed to make initial payments totaling $4.0 million, with
subsequent payments to be made upon completion of certain milestones and a
royalty on net sales of products using this chemical compound.
In 2000, we began collaborating with AeroGen, Inc. to develop and register
a product combining TOBI with a customized version of AeroGen's hand-held,
portable AeroDose Inhaler. Under our development and supply agreement, we will
reimburse AeroGen for costs incurred in developing the AeroDose Inhaler and will
obtain worldwide exclusive distribution rights to the product. AeroGen will
receive royalties on all product sales. PathoGenesis also invested $2.5 million
in convertible preferred stock of privately held AeroGen. Based in Sunnyvale,
California, AeroGen develops pulmonary drug delivery products for local
treatment of respiratory diseases and for input to the systemic circulation.
In 2000, we announced a collaboration with Chiron Corp. (Nasdaq: CHIR) to
develop new antibiotics with new mechanisms of action to better address serious
medical needs, such as concerns about drug resistance. The
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collaboration seeks to combine Chiron's strong combinatorial chemistry library
and expertise in high-throughput screening with our strengths in bacterial
target discovery and antibiotic development, as well as our knowledge of the P.
aeruginosa genome.
We engage in other research and development collaborations and licensing
arrangements with various academic institutions, government and commercial
research groups, and other companies. For example, we entered into a contract
with the Cystic Fibrosis Foundation and the University of Washington to sequence
the P. aeruginosa genome as described under "Research and Development." We
believe that none of the licenses under those other arrangements is currently
material in relation to our business as a whole. We expect to pursue additional
license agreements and research collaboration arrangements.
Patents
PathoGenesis generally applies for patents for its proprietary compounds,
formulations or technologies. Our patent protection includes a U.S. formulation
patent on TOBI that will expire in 2013.
Government Regulation and Product Testing
In order to conduct clinical trials and to manufacture and market products
for therapeutic use, PathoGenesis must comply with regulation by governmental
authorities in the U.S. and other countries. We also are subject to various
federal, state and local laws, regulations and recommendations, including
environmental laws and regulations.
Before a drug may be commercially distributed in the U.S., its developer
must complete the following steps:
. conduct preclinical laboratory and animal tests
. submit an Investigational New Drug (IND) application that must be approved
by the FDA before clinical trials may begin
. conduct controlled human clinical trials to establish the safety and
efficacy of the drug candidate
. file a New Drug Application (NDA) with the FDA
. comply with FDA inspection of drug manufacturing facilities to ensure
compliance with applicable requirements
. obtain FDA approval of the NDA prior to any commercial sale or shipment of
the drug.
Clinical trials involve the administration of an investigational drug
product to human subjects. In Phase I, the drug candidate is first tested in
humans for safety, side effects, dosage tolerance, metabolism and clinical
pharmacology. Phase II trials help determine efficacy, optimal dosage and
possible side effects in specific indications. Phase III trials are undertaken
to gather additional information about efficacy and safety in order to evaluate
the drug candidate's risks and benefits and to provide an adequate basis for
product labeling.
Upon approval in the U.S., a drug may be marketed only for the approved
indications in the approved dosage forms and dosages. The FDA may require post-
marketing testing and surveillance to monitor the safety and efficacy history of
an approved product and continued compliance with regulatory requirements. The
FDA also may require an additional review of manufacturing facilities if a
material change is made to manufacturing equipment, locations or processes.
In marketing our products outside the U.S., we must comply with the varying
regulations of international markets. Marketing authorizations generally are
approved at the national level. If a regulatory authority is satisfied that
adequate evidence of safety, quality and efficacy has been presented, marketing
authorization is usually granted. In the European Union, the mutual recognition
approval process is available to companies wishing to market a product in more
than one country in the Union. Based on TOBI's regulatory approval in the U.K.,
we are requesting that the other European Union countries approve our inhaled
drug under the mutual recognition process. Approval by the FDA and similar
health authorities does not ensure approval by other countries where TOBI is
under regulatory review.
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Competition
PathoGenesis competes with pharmaceutical companies and specialized
biotechnology firms that produce and market products in the United States,
Europe and elsewhere. Many pharmaceutical companies have focused their
development efforts in the therapeutics areas we are pursuing and may have
substantially greater financial, research and development resources. We expect
to encounter significant competition for the principal products we plan to
develop.
The use of antibiotics to treat pseudomonal and other bacterial infections
is well-established. In cystic fibrosis patients with pseudomonal lung
infections, tobramycin is the most commonly used intravenous antibiotic. Medical
therapies for patients with CF include antibiotics, anti-inflammatory drugs,
oral replacement enzymes to maintain nutrition, physical therapy to the chest to
loosen lung secretions, and mucolytics to clear pulmonary secretions. We believe
those CF therapies complement TOBI. However, the optimal combination may vary
among patients. In addition, the potential high cost of combination therapy may
limit the use of TOBI in conjunction with other therapies. There can be no
assurance that alternative formulations of tobramycin, other antibiotics or
different approaches to therapy will not prove to be more efficacious, safer or
more cost-effective than TOBI.
Human Resources
As of December 31, 1999, PathoGenesis had 283 employees, of which 157 were
engaged in research and development and 68 in sales and marketing. A significant
number of our management and professional employees have had prior experience
with pharmaceutical, biotechnology or medical products companies. None of our
employees are covered by collective bargaining agreements. We have entered into
confidentiality agreements with all our employees.
Item 2. Properties
Our principal facility consists of approximately 71,000 square feet of
leased laboratory and office space in Seattle, Washington. The lease expires in
March 2003. We have subleased a portion of this space to a third party. We have
also leased about 32,000 square feet of additional office space in Seattle to
accommodate our growth as a commercial enterprise. This lease also expires in
March 2003.
We also lease an administrative and sales and marketing office of
approximately 13,000 square feet in Skokie, Illinois. This lease expires in
March 2003. Additional leased laboratory and office space in Annandale, New
Jersey consists of approximately 37,000 square feet and houses manufacturing and
distribution support operations. The lease expires in December 2001.
In 1998, we purchased an office building consisting of approximately 8,000
square feet in Cranford, Middlesex, England to house the operations of
PathoGenesis Limited. This wholly owned subsidiary of PathoGenesis Corporation
is leading our European expansion efforts.
Item 3. Legal Proceedings
On February 18, 2000, the United States District Court for the Western
District of Washington dismissed with prejudice all eight consolidated putative
class action lawsuits that had been filed in March and April 1999 against
PathoGenesis Corporation, our chief executive officer and our chief financial
officer. The eight consolidated lawsuits (Lipton v. PathoGenesis et al., C99-
0419; Green v. PathoGenesis et al., C99-0439; Gellert v. PathoGenesis et al.,
C99-0452; May v. PathoGenesis et al., C99-0453; Shapiro v. PathoGenesis et al.,
C99-0455; Bassin v. PathoGenesis et al., C99-0469; Barker v. PathoGenesis et
al., C99-0503; and Kralovk v. PathoGenesis et al., C99-0506) purported to allege
claims on behalf of all purchasers of PathoGenesis common stock during the
period January 15, 1999 to March 22, 1999. Plaintiffs had claimed that the
company and the officers violated certain provisions of the federal securities
laws by making statements in early 1999 regarding the company's 1998 financial
results. The court's order dismissed the consolidated cases and bars plaintiffs
from filing another lawsuit on the matter. Plaintiffs have appealed the
dismissal order to the United States Court of Appeals for the Ninth Circuit. We
intend to defend the appeal vigorously. Although we cannot ascertain the
ultimate outcome of the appeal at this
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time or predict with certainty the results of legal proceedings, we currently
believe that the resolution of the appeal will not have a material adverse
effect on our financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
We did not submit any matter to a vote of security holders during the
fourth quarter of 1999.
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PART II
Item 5. Market for the Company's Common Stock and Related Stockholder Matters
PathoGenesis' common stock trades on the Nasdaq National Market under the
symbol PGNS. As of March 17, 2000, there were approximately 404 holders of
record of common stock. However, we believe the actual number of beneficial
holders is substantially greater. The company has not paid any cash dividends on
the common stock to date, and currently intends to retain any earnings for the
development and growth of its business.
The following table shows the range of high and low sales prices of the
common stock as quoted on the Nasdaq National Market for each quarter in 1999
and 1998. On March 17, 2000, the last reported sale price for the common stock
was $25.75.
High Low
1999:
Fourth Quarter................................ $ 23.00 $ 14.00
Third Quarter................................. 20.688 13.00
Second Quarter................................ 15.875 11.125
First Quarter................................. 59.00 10.063
1998:
Fourth Quarter................................ 61.50 29.625
Third Quarter................................. 37.00 22.00
Second Quarter................................ 40.375 26.313
First Quarter................................. 40.25 31.00
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Item 6. Selected Financial Data
In the table below, we present selected financial data for each of the five
years ended December 31, 1999, 1998, 1997, 1996 and 1995. We derived this
information from our consolidated financial statements. Please read the data
below in conjunction with the audited consolidated financial statements, related
notes and the other financial information included in this report.
<TABLE>
<CAPTION>
In thousands, except per share data Years ended December 31,
---------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------- --------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues:
Sales................................. $60,052 $60,684 $ -- $ -- $ --
Grants and royalties.................. 792 368 442 440 --
------- ------- -------- -------- --------
Total revenues...................... 60,844 61,052 442 440 --
Operating expenses:
Cost of sales......................... 11,239 9,555 -- -- --
Research and development.............. 30,397 28,993 28,018 20,673 15,668
Selling, general and administrative... 29,165 20,074 10,582 4,241 3,609
License fee........................... -- 4,000 -- -- --
------- ------- -------- -------- --------
Total operating expenses............ 70,801 62,622 38,600 24,914 19,277
------- ------- -------- -------- --------
Operating loss...................... (9,957) (1,570) (38,158) (24,474) (19,277)
------- ------- -------- -------- --------
Other income (expense):
Investment income, net................ 2,707 4,056 5,278 3,294 1,287
Interest expense...................... (627) (493) -- -- --
Other expense......................... (318) (110) (158) (84) (34)
------- ------- -------- -------- --------
Net other income.................... 1,762 3,453 5,120 3,210 1,253
------- ------- -------- -------- --------
Net income (loss)................... $(8,195) $ 1,883 $(33,038) $(21,264) $(18,024)
======= ======= ======== ======== ========
Income (loss) per common share:
Basic................................. $(0.50) $0.12 $(2.10) $(1.66) $ (2.20)
======= ======= ======== ======== ========
Diluted............................... $(0.50) $0.11 $(2.10) $(1.66) $ (2.20)
======= ======= ======== ======== ========
Weighted average common shares
outstanding:
Basic................................. 16,407 16,265 15,704 12,829 8,210
Diluted............................... 16,407 17,156 15,704 12,829 8,210
</TABLE>
<TABLE>
<CAPTION>
In thousands At December 31,
---------------------------------------------------------------------------
1999 1998 1997 1996 1995
-------------- ------------- -------------- -------------- ------------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and investment
securities............................ $ 45,006 $ 55,007 $79,041 $60,688 $37,447
Total current assets................... 68,211 79,784 87,190 61,809 38,884
Total assets........................... 100,837 112,766 97,596 69,999 46,963
Total current liabilities.............. 14,422 14,631 8,107 2,974 3,453
Long-term liability.................... -- 4,725 -- 98 462
Total stockholders' equity............. 86,414 93,410 89,489 66,926 43,048
</TABLE>
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Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
In reading the discussion below, you should keep in mind that it contains
forward-looking statements involving risks and uncertainties that affect our
future operating results. Those factors include, but are not limited to,
uncertainties related to the fact that PathoGenesis only began commercial
operations in 1998, its dependence on TOBI, the degree of penetration of its
markets and frequency of TOBI's use by patients, risks associated with marketing
TOBI in international markets, third party reimbursement and product pricing,
seasonal impacts on hospitalizations or exacerbations experienced by patients,
variability in wholesaler ordering patterns, drug development and clinical
trials, uncertain outcome of the U.S. and international drug approval process,
competition and alternative therapies. A discussion of some of those factors is
included in Exhibit 99.1 of this report.
Results of Operations
Years Ended December 31, 1999 and 1998
Revenues. Revenues in 1999 totaled $60.8 million, including $60.1 million
from TOBI sales. Research grants and royalties generated the balance of
$792,000. Revenues for 1998 were $61.1 million, including $60.7 million from
TOBI sales in the first year of the drug's launch. Research grants and royalties
generated the balance of $368,000 in 1998. Because we launched TOBI in 1998,
sales in that year benefited from initial purchases of stock to fill the
distribution chain. In addition, our 1999 and 1998 sales were affected by
quarterly fluctuations in ordering patterns for TOBI. Quarterly TOBI sales
volume is influenced by a number of factors, including underlying demand and
wholesaler inventory management practices.
Operating Expenses. We incurred total operating expenses of $70.8 million
in 1999, an increase of $8.2 million from $62.6 million in 1997. Cost of sales
was $11.2 million in 1999, an increase of $1.7 million from $9.6 million in
1998. This increase in the cost of sales is the result of a reduction in the
number of manufacturing batches in 1999, leading to a higher portion of
manufacturing costs being charged directly to cost of sales. Research and
development expense for 1999 increased by $1.4 million to $30.4 million from
$29.0 million in 1998. Selling, general and administrative expenses increased to
$29.2 million in 1999 from $20.1 million in 1998 due mainly to increased sales
and marketing costs. In 1999, we increased our U.S. sales force 30%. We also
expanded our advisory board of respected cystic fibrosis physicians, who are
assisting us in communicating the extensive data now available on TOBI. We also
made significant strides in expanding the international market for TOBI. In 1999
and early 2000, we received regulatory approvals to market TOBI in Canada,
Argentina, Israel, Australia and the United Kingdom. General and administrative
expenses also rose due to staff-related and consulting costs.
Net Income (Loss). We had an operating loss of $10.0 million in 1999, an
increase of $8.4 million from the operating loss of $1.6 million in 1998. This
increased loss was due to higher operating expenses in 1999, primarily relating
to sales and marketing costs. Including net other income (primarily income from
investment securities), our net loss for 1999 was $8.2 million, compared to net
income of $1.9 million in 1998. In 1999, net investment income decreased by $1.4
million to $2.7 million from $4.1 million in 1998. The decrease was primarily
due to lower average invested cash balances. Interest expense, most of which
represents the amortization of the discount on the remaining installments of our
obligation to the Cystic Fibrosis Foundation, totaled $627,000 and $493,000 in
1999 and 1998, respectively.
Years Ended December 31, 1998 and 1997
Revenues. Revenues in 1998 totaled $61.1 million, including $60.7 million
from TOBI sales in the first year of the drug's launch. Research grants and
royalties generated the balance of $368,000. Revenues for 1997 were $442,000,
which were entirely generated by research grants and royalties.
Operating Expenses. We incurred total operating expenses of $62.6 million
in 1998, an increase of $24.0 million from $38.6 million in 1997. The costs of
manufacturing and marketing TOBI accounted for the majority of the increase. A
$4.0 million license fee to Bristol-Myers Squibb for PA-1806, a novel, patented
drug candidate being developed as an inhaled antibiotic, also represented a
significant portion of the increase. Cost of sales was $9.6 million in 1998. We
did not incur such costs in 1997 because sales did not begin until 1998. Our
research and
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development expense for 1998 increased by $1.0 million to $29.0 million from
$28.0 million in 1997. These costs rose as we continued to develop new drug
candidates and pursue regulatory approval of TOBI in Canada, Europe and other
markets. Selling, general and administrative expenses increased to $20.1 million
in 1998 from $10.6 million in 1997. The increase primarily reflects the costs
associated with supporting our U.S. sales and marketing effort, adding
administrative staff and developing a sales and marketing program in Europe.
Net Income (Loss). We had an operating loss of $1.6 million in 1998, a
decrease of $36.6 million from the operating loss of $38.2 million in 1997. This
decline in operating loss was due to TOBI sales revenues in 1998. Including net
other income (primarily income from investment securities), our net income for
1998 was $1.9 million, compared to a net loss of $33.0 million in 1997. In 1998,
net investment income decreased by $1.2 million to $4.1 million from $5.3
million in 1997. The decrease was primarily due to lower average invested cash
balances. Interest expense in 1998 totaled $493,000. We had no interest expense
in 1997.
Liquidity and Capital Resources
Our combined cash, cash equivalents and investment securities totaled $45.0
million at December 31, 1999, a decrease of $10.0 million from the balance of
$55.0 million at December 31, 1998. We expect that these funds, in combination
with expected revenues from sales of TOBI, should be sufficient to meet our
operating expenses and capital requirements for the foreseeable future. In
addition, we obtained a $10.0 million revolving line of credit in 1999 from
Harris Trust and Savings Bank.
Net cash used in operating activities totaled $1.2 million for 1999,
compared to $9.6 million in 1998. We incurred an $8.2 million net loss for 1999,
compared to net income of $1.9 million for 1998. Significant changes in working
capital components included a $4.9 million decrease in accounts receivable and
$4.7 million increase in inventory, compared to increases of $11.0 million and
$5.0 million, respectively, in 1998. Also, license payable decreased by $2.0
million in 1999 as we paid the second half of our initial obligation to Bristol-
Myers Squibb. In addition, during 1999 we purchased $4.4 million in property and
equipment and made our second installment payment of $5.3 million for the rights
in TOBI acquired from the Cystic Fibrosis Foundation. At December 31, 1999, our
working capital was $53.8 million and current ratio was 4.73 to 1.
In 2000, we expect net cash flow from operations to be about break-even. We
expect to incur capital expenditures of approximately $4.0 million to $6.0
million. In March 2000, we invested $2.5 million in convertible preferred stock
of privately held AeroGen, Inc. In addition, the final installment payment of
$5.3 million to the Cystic Fibrosis Foundation will be due in May 2000. This
cash flow projection does not include the effects of any licensing or
collaboration agreements which we may enter into in 2000.
We plan to continue our policy of investing excess funds in government
securities and investment grade, interest-bearing securities, primarily those
with an expected maturity of one-and-one-half years or less. We do not invest in
derivative financial instruments, as defined by Statement of Financial
Accounting Standards (SFAS) No. 119, Disclosure About Derivative Financial
Instruments and Fair Value of Financial Instruments.
At December 31, 1999, we had tax net operating loss carryforwards of
approximately $100.6 million and research and experimentation tax credit
carryforwards of approximately $1.5 million, both of which will begin to expire
in 2007. We also have orphan drug credits of approximately $5.0 million, which
will expire beginning in 2007.
Outlook
We expect sales of TOBI to increase in 2000, as we further penetrate the
U.S. cystic fibrosis market, gain approvals for TOBI in international markets
and expand TOBI's use in other patients with serious lung infections. We expect
cost of sales as a percentage of sales to decline slightly in 2000 as sales
volumes increase. We expect our sales and marketing costs to continue increasing
at a rate comparable to prior years as we expand U.S. sales and open new markets
in Europe and elsewhere. Having received marketing approval for TOBI in the
U.K., we are seeking approval for TOBI from the other European Union countries
through a mutual recognition process. We are marketing TOBI using our own sales
force in the U.K. and Canada. We intend to market TOBI ourselves in several
other countries, while working through distributors elsewhere. To date, we have
secured agreements with
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specialized local distributors in Argentina, Australia, Cyprus, Germany, Greece,
Israel, Italy and the Nordic countries.
Research and development costs are expected to increase in 2000 as we
invest in a number of new development initiatives. For example, we intend to
conduct or co-sponsor a number of Phase IV clinical trials of TOBI in cystic
fibrosis, bronchiectasis, ventilator-associated pneumonia and lung transplant
patients. In addition, we currently plan to begin Phase I clinical trials of PA-
1806 later in 2000.
We have begun a program to develop a more convenient version of TOBI. Our
goal is to reduce TOBI's delivery time from 15-20 minutes to 5-10 minutes or
less. Drug delivery companies are developing new generations of nebulizers and
dry powder delivery devices that were not available when TOBI was formulated in
1994. These devices are hand-held, portable and do not require the use of an
electrically powered air compressor. In March 2000, we entered into an agreement
with AeroGen, Inc. to collaborate on the development and registration of a
product combining TOBI and AeroGen's hand-held, portable AeroDose(TM) Inhaler.
Under the development and supply agreement, we will reimburse AeroGen for costs
incurred in developing the AeroDose Inhaler and will obtain worldwide exclusive
distribution rights to the product. AeroGen will receive royalties on all
product sales.
We also intend to select and initiate development of at least one other
antibiotic for inhalation to address broader respiratory infection markets, as a
result of our own research programs and collaborations with others. In January
2000, we announced a research collaboration with Chiron Corp., with the goal of
identifying new classes of antibiotics for oral, intravenous and inhaled
administration that could address the increasingly important issue of drug
resistance. The collaboration seeks to combine Chiron's strong combinatorial
chemistry library and expertise in high-throughput screening with our strengths
in bacterial target discovery and antibiotic development, as well as our
knowledge of the P. aeruginosa genome (genetic structure).
Year 2000
We completed our year 2000 compliance program in late 1999, which included
verification testing of our internal information technology and information
systems. In addition, we contacted key third parties, such as suppliers,
customers and financial institutions, to assure no interruption of our business
relationships would occur due to year 2000 compliance issues. Our existing
systems that were not year 2000-compliant represented a small percentage of our
systems, and almost all noncompliant systems were replaced as part of normal
technology upgrades in 1999. The remaining systems were evaluated on an
individual basis, and upgraded or replaced as necessary. Our total year 2000
compliance costs were approximately $50,000 in 1999, excluding the costs of
technology upgrades made in the ordinary course of business.
Our systems successfully transitioned to the year 2000, and to date we have
not experienced any significant problems associated with year 2000 issues.
However, there may be latent problems that surface at certain dates or events in
the future. We will continue to monitor our systems and those of key third
parties throughout the year 2000 to ensure that any latent problems are
addressed promptly.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to the impact of interest rate changes and changes in the
market values of our investments, in addition to changes in foreign currency
exchange rates.
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates
primarily to debt securities included in our investment portfolio. We do not
hold any derivative financial instruments. We invest in government securities
and high-quality corporate obligations. Investments in both fixed rate and
floating rate interest-earning instruments carry a degree of interest rate risk.
Fixed rate securities may have their fair market value adversely impacted due to
a rise in prevailing interest rates, while floating rate securities may produce
less income than expected if prevailing interest rates fall. Due in part to
these factors, our future investment income may fall short of expectations due
to changes in interest rates, or we may suffer losses in principal if forced to
sell securities which have declined in market value due to changes in interest
rates. At December 31, 1999, we owned $3.7 million in government debt
18
<PAGE>
instruments and $30.8 million in corporate debt securities. Our exposure to
losses as a result of interest rate changes is managed through investing in
securities predominantly with maturities of one-and-one-half years or less.
Foreign Currency Risk
Substantially all the revenue and operating expenses of our subsidiaries
are denominated in local currencies and translated into U.S. dollars at rates of
exchange approximating those existing at the date of the transactions. Foreign
currency translation primarily impacts revenue and operating expenses as a
result of exchange rate fluctuations. Because our inventories are manufactured
in the U.S., foreign currency fluctuations generally do not affect our cost of
sales. Our foreign currency transaction risk is primarily limited to amounts
receivable from our subsidiaries and distributors, which are denominated in
local currencies. We do not currently utilize foreign currency hedging
contracts. If the U.S. dollar uniformly increases in strength by 10% in 2000
relative to the currencies in which our sales are denominated, income before
taxes would not be significantly impacted.
Item 8. Consolidated Financial Statements
The consolidated financial statements for the fiscal year ended December
31, 1999 appear beginning on page F-1 of this annual report on Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
19
<PAGE>
PART III
Item 10. Directors and Executive Officers of Registrant
The information appearing under the captions "Election of Directors,"
"Executive Officers" and "Security Ownership of Certain Beneficial Owners and
Management - Did directors and executive officers comply with Section 16(a)
beneficial ownership report requirements in 1999?" in the proxy statement for
the annual meeting of stockholders to be held on May 31, 2000, is incorporated
in this report by reference.
Item 11. Executive Compensation
Information appearing under the caption "Executive Compensation" in the
proxy statement for the 2000 annual meeting is incorporated in this report by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information included under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the proxy statement for the 2000 annual
meeting is incorporated in this report by reference.
Item 13. Certain Relationships and Related Transactions
None.
20
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Documents Filed As a Part of This Report
(1) Financial Statements. PathoGenesis' consolidated balance sheets as of
December 31, 1999 and 1998, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the years
in the three-year period ended December 31, 1999, together with the
report of its Independent Auditors, appear beginning on page F-1.
(2) Financial Statement Schedule. The following schedule supporting the
foregoing consolidated financial statements for the years ended
December 31, 1999 and 1998, is filed as part of this Form 10-K.
Schedule II. Valuation and Qualifying Accounts - page 22
Report of Independent Auditors on Schedule - page 23
All other schedules are omitted because they are not applicable, not
required, or because the required information is included in the
consolidated financial statements or notes thereto.
(3) Exhibits. The exhibits to this report are listed in the Exhibit Index
included at the end of this report. Included in the exhibits listed in
the Index are the following exhibits which constitute management
contracts or compensatory plans or arrangements:
10.3 Employment Agreement between the Company and A. Bruce
Montgomery, dated September 19, 1995
10.4 Employment Agreement between the Company and Marc F.
Wipperman, effective as of July 1, 1996
10.26 1992 Stock Option Plan
10.27 1996 Non-Employee Director Plan
10.28 1997 Stock Option Plan and related Form of Stock Option
Agreement
10.32 Form of Change in Control Employment Agreement for certain
key employees
10.34 1999 Employee Stock Option Plan and related Form of Stock
Option Agreement
10.35 1999 Stock Plan and related Form of Stock Option Agreement
10.36 Employee Stock Purchase Plan
10.37 401(k) Profit Sharing Plan and related Trust Agreement
(b) Reports on Form 8-K
PathoGenesis filed a report on Form 8-K on December 15, 1999, upon
receiving regulatory approval to market TOBI in the U.K.
(c) Exhibits
The exhibits to this report are listed in the Exhibit Index which appears
after the signature page of this report and is hereby incorporated by reference.
21
<PAGE>
SCHEDULE II
Valuation and Qualifying Accounts
Years Ended December 31, 1999 and 1998
<TABLE>
<CAPTION>
Balance at Balance
beginning at end
of year Additions Deductions of year
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Year ended December 31, 1998
Allowances for discounts, returns,
bad debts, chargebacks and rebates $ -- $ 3,554,436 $ 2,003,572 $ 1,550,864
Year ended December 31, 1999
Allowances for discounts, returns,
bad debts, chargebacks and rebates $ 1,550,864 $ 6,098,929 $ 4,462,420 $ 3,187,373
</TABLE>
22
<PAGE>
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
The Board of Directors and Stockholders
PathoGenesis Corporation:
Under the date of January 21, 2000 except as to note 12, which is as of
March 23, 2000, we reported on the consolidated balance sheets of PathoGenesis
Corporation and subsidiaries as of December 31, 1999 and 1998, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the years in the three-year period ended December 31, 1999, as contained
in the 1999 Annual Report on Form 10-K. In connection with our audits of the
aforementioned consolidated financial statements, we also audited the
related consolidated financial statement schedule of valuation and qualifying
accounts for the years ended December 31, 1999 and 1998 contained in the 1999
Annual Report on Form 10-K. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
KPMG LLP
Seattle, Washington
January 21, 2000
23
<PAGE>
PATHOGENESIS CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page No.
--------
Independent Auditors' Report............................................ F-2
Consolidated Balance Sheets as of December 31, 1999 and 1998............ F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1999, 1998 and 1997...................................... F-4
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1999, 1998 and 1997...................................... F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1999, 1998 and 1997...................................... F-6
Notes to Consolidated Financial Statements.............................. F-7
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
PathoGenesis Corporation:
We have audited the accompanying consolidated balance sheets of
PathoGenesis Corporation and subsidiaries (Company) as of December 31, 1999 and
1998, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of PathoGenesis
Corporation and subsidiaries as of December 31, 1999 and 1998, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1999, in conformity with generally accepted accounting
principles.
KPMG LLP
Seattle, Washington
January 21, 2000,
except as to note 12, which is as of
March 23, 2000
F-2
<PAGE>
PATHOGENESIS CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31,
--------------------------------------
Assets 1999 1998
------------------ -----------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 10,456,031 $ 8,139,153
Investment securities 34,549,738 46,868,390
Accounts receivable, net 6,038,299 10,961,242
Interest receivable 442,676 427,618
Inventories 14,613,385 9,907,916
Other current assets 2,110,610 3,480,022
------------------ -----------------
Total current assets 68,210,739 79,784,341
------------------ -----------------
Restricted investment -- 675,000
Property and equipment, at cost:
Land 3,030,938 3,194,923
Building and improvements 1,454,850 1,515,543
Leasehold improvements 9,735,242 9,367,898
Furniture and equipment 16,948,235 13,263,162
------------------ -----------------
31,169,265 27,341,526
Less accumulated depreciation and amortization 12,957,926 9,704,385
------------------ -----------------
Net property and equipment 18,211,339 17,637,141
------------------ -----------------
License rights, net 13,591,321 14,562,129
Other assets 823,519 107,136
------------------ -----------------
$ 100,836,918 $ 112,765,747
================== =================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 1,668,775 $ 1,180,909
Compensation and benefits 2,524,184 2,580,790
Clinical development costs 1,391,383 199,869
Accrued royalties 906,629 827,739
License payable -- 2,000,000
Other accrued expenses 2,781,644 2,691,572
Current portion of long-term liability 5,149,847 5,149,847
------------------ -----------------
Total current liabilities 14,422,462 14,630,726
------------------ -----------------
Long-term liability, net of current portion -- 4,724,630
Commitments and subsequent events
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized 1,000,000 shares;
none issued and outstanding -- --
Common stock, $0.001 par value. Authorized 60,000,000 shares;
16,451,530 shares and 16,328,580 shares issued and outstanding
at December 31, 1999 and 1998, respectively 16,452 16,329
Additional paid-in capital 194,641,919 193,188,363
Deferred compensation (526,199) (987,156)
Accumulated other comprehensive income (loss) (582,036) 133,117
Accumulated deficit (107,135,680) (98,940,262)
------------------ -----------------
Total stockholders' equity 86,414,456 93,410,391
------------------ -----------------
$ 100,836,918 $ 112,765,747
================== =================
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
PATHOGENESIS CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Years ended December 31,
----------------------------------------------
1999 1998 1997
------------- ------------- --------------
<S> <C> <C> <C>
Revenues:
Sales $ 60,052,486 $ 60,684,091 $ --
Grants and royalties 791,739 367,673 441,880
------------- ------------- --------------
Total revenues 60,844,225 61,051,764 441,880
------------- ------------- --------------
Operating expenses:
Cost of sales 11,239,170 9,555,213 --
Research and development 30,397,456 28,992,714 28,017,738
Selling, general and administrative 29,164,673 20,073,736 10,582,072
License fee -- 4,000,000 --
------------- ------------- --------------
Total operating expenses 70,801,299 62,621,663 38,599,810
------------- ------------- --------------
Operating loss (9,957,074) (1,569,899) (38,157,930)
------------- ------------- --------------
Other income (expense):
Investment income, net 2,706,739 4,055,821 5,278,098
Interest expense (626,727) (492,551) --
Other expense (318,356) (110,470) (157,898)
------------- ------------- --------------
Net other income 1,761,656 3,452,800 5,120,200
------------- ------------- --------------
Net income (loss) $ (8,195,418) $ 1,882,901 $ (33,037,730)
============= ============= ==============
Income (loss) per common share:
Basic $ (0.50) $ 0.12 $ (2.10)
============= ============= ==============
Diluted $ (0.50) $ 0.11 $ (2.10)
============= ============= ==============
Weighted average common shares outstanding:
Basic 16,406,734 16,265,452 15,704,151
Diluted 16,406,734 17,155,691 15,704,151
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
PATHOGENESIS CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Number of Accumulated
common Additional other Total
shares Common paid-in Deferred comprehensive Accumulated stockholders'
Description outstanding stock capital compensation income (loss) deficit equity
------------ ------- ------------ ------------- ------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1996 13,930,760 $13,931 $134,727,920 $ -- $ (30,204) $ (67,785,433) $ 66,926,214
Shares issued for
cash, net of issue
costs of $3,546,639 2,100,000 2,100 53,151,262 -- -- -- 53,153,362
Exercise of options
and warrants 207,889 208 2,140,248 -- -- -- 2,140,456
Deferred compensation
from granting of
stock options -- -- 1,594,024 (1,594,024) -- -- --
Compensation expense
from stock options -- -- -- 298,879 -- -- 298,879
Comprehensive loss -- -- -- -- -- -- --
Net loss -- -- -- -- -- (33,037,730) (33,037,730)
Unrealized gain on
investment securities -- -- -- -- 7,569 -- 7,569
-------------
Total comprehensive loss -- -- -- -- -- -- (33,030,161)
------------ ------- ------------ ------------- ------------- -------------- -------------
Balances at December 31, 1997 16,238,649 16,239 191,613,454 (1,295,145) (22,635) (100,823,163) 89,488,750
Exercise of stock options 89,931 90 1,373,827 -- -- -- 1,373,917
Deferred compensation
from granting of
stock options -- -- 201,082 (201,082) -- -- --
Compensation expense
from stock options -- -- -- 509,071 -- -- 509,071
Comprehensive income -- -- -- -- -- -- --
Net income -- -- -- -- -- 1,882,901 1,882,901
Unrealized gain on
investment securities -- -- -- -- 155,752 -- 155,752
-------------
Total comprehensive income -- -- -- -- -- -- 2,038,653
------------ ------- ------------ ------------- ------------- -------------- -------------
Balances at December 31, 1998 16,328,580 16,329 193,188,363 (987,156) 133,117 (98,940,262) 93,410,391
Exercise of stock options
and warrants 59,889 60 541,594 -- -- -- 541,654
Shares purchased through
employee stock purchase plan 63,061 63 911,962 -- -- -- 912,025
Compensation expense
from stock options -- -- -- 460,957 -- -- 460,957
Comprehensive loss
Net loss -- -- -- -- -- (8,195,418) (8,195,418)
Foreign currency
translation adjustments -- -- -- -- (287,183) -- (287,183)
Unrealized loss on
investment securities -- -- -- -- (427,970) -- (427,970)
-------------
Total comprehensive loss -- -- -- -- -- -- (8,910,571)
------------ ------- ------------ ------------- ------------- -------------- -------------
Balances at December 31, 1999 16,451,530 $16,452 $194,641,919 $ (526,199) $ (582,036) $(107,135,680) $ 86,414,456
============ ======= ============ ============= ============= ============== =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
PATHOGENESIS CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years ended December 31,
------------------------------------------------------------
1999 1998 1997
----------------- ----------------- ------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (8,195,418) $ 1,882,901 $ (33,037,730)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization 3,468,865 2,566,335 2,076,900
Amortization of license rights 970,808 153,131 --
Amortization of discount on long-term liability 608,703 492,551 --
Compensation expense from stock options 460,957 509,071 298,879
Loss on sale of property and equipment 16,975 -- 42,643
Changes in certain assets and liabilities:
Accounts receivable 4,922,943 (10,961,242) --
Interest receivable (15,058) 228,778 (357,959)
Inventories (4,705,492) (4,972,158) (4,935,758)
Other current assets 1,352,705 (923,613) (1,733,317)
Other assets 54,403 15,053 (21,819)
Accounts payable 503,177 12,044 356,606
Compensation and benefits (56,606) 1,119,623 686,909
Clinical development costs 1,190,489 (2,685,238) 2,066,478
Accrued royalties 78,890 827,739 --
License payable (2,000,000) 2,000,000 --
Other accrued expenses 104,190 99,912 2,022,592
Other -- -- (65,191)
----------------- ----------------- ------------------
Net cash used in operating activities (1,239,469) (9,635,113) (32,600,767)
----------------- ----------------- ------------------
Cash flows from investing activities:
Purchases of investment securities (31,702,730) (47,736,796) (177,646,664)
Sales of investment securities 44,268,412 74,893,699 149,653,588
Purchases of property and equipment (4,385,659) (10,594,811) (4,370,202)
Proceeds from sale of property and equipment 73,755 -- 56,000
Purchases of other assets (810,893) -- --
Purchase of license rights -- (5,333,334) --
----------------- ----------------- ------------------
Net cash provided by (used in) investing activities 7,442,885 11,228,758 (32,307,278)
----------------- ----------------- ------------------
Cash flows from financing activities:
Net proceeds from issuance of common stock -- -- 53,153,362
Proceeds from issuance of common stock in connection
with employee stock purchase plan 912,025 -- --
Stock option and warrant exercises 541,654 1,373,917 2,140,456
Payment of long-term liability (5,333,333) -- --
----------------- ----------------- ------------------
Net cash provided by (used in) financing activities (3,879,654) 1,373,917 55,293,818
----------------- ----------------- ------------------
Effect of exchange rate changes on cash (6,884) -- --
----------------- ----------------- ------------------
Net increase (decrease) in cash and
cash equivalents 2,316,878 2,967,562 (9,614,227)
Cash and cash equivalents at beginning of year 8,139,153 5,171,591 14,785,818
----------------- ----------------- ------------------
Cash and cash equivalents at end of year $ 10,456,031 $ 8,139,153 $ 5,171,591
================= ================= ==================
Supplemental schedule of noncash investing and
financing activities - Seller-financed
acquisition of license rights $ -- $ 9,381,926 $ --
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
PATHOGENESIS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, December 31, 1999 and 1998
(1) Organization and Summary of Significant Accounting Policies
Business
PathoGenesis Corporation is a pharmaceutical company that develops and
commercializes drugs to treat chronic infectious diseases where there is a
significant need for improved therapy. We market TOBI(R) (tobramycin
solution for inhalation), an inhaled antibiotic, for management of P.
aeruginosa lung infections in patients with cystic fibrosis. In addition,
PathoGenesis is developing other drug candidates to treat serious chronic
lung infections, including those common in cystic fibrosis, bronchiectasis
and ventilator patients.
Concentrations of Risk
Substantially all our revenue is currently generated through sales of TOBI.
Our other drug candidates are not expected to be commercially available for
at least several years, if at all. Therefore, a significant change in
demand or pricing for TOBI, or the introduction of a competing product, are
among the factors that could have a material impact on our operations.
PathoGenesis uses wholesale distributors of pharmaceutical products as the
principal means of distributing TOBI to clinics, hospitals and pharmacies.
For 1999 and 1998, sales to our three largest wholesale distributors were
64% and 65% of total sales, respectively. Accounts receivable from these
distributors were 44% and 63% of total accounts receivable at December 31,
1999 and 1998, respectively.
We purchase our primary basic raw material, bulk powdered tobramycin, from
two of the principal worldwide suppliers of the drug. We anticipate that
either one of these suppliers alone will be able to supply sufficient
quantities to meet current needs. However, there can be no assurance that
these suppliers will be able to meet future demand in a timely and cost-
effective manner. Our operations could be adversely affected by an
interruption or reduction in the supply of raw material.
PathoGenesis has entered into contracts with third parties for the
production and packaging of TOBI. Our reliance on external sources of
production and packaging can be shifted, over time, to alternative sources
should such changes be necessary. However, if the contract manufacturers
become unable to produce or package sufficient quantities of TOBI due to
work stoppages or other factors beyond our control, our operations could be
disrupted until alternative sources are secured.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of
the company and its wholly owned subsidiaries, PathoGenesis Limited and
PathoGenesis Canada Limited. All significant intercompany accounts and
transactions have been eliminated in consolidation.
Cash Equivalents
All investments in debt instruments with a contractual maturity of three
months or less at the date of purchase are considered to be cash
equivalents. Cash equivalents totaled $1,900,000 at December 31, 1999.
There were no cash equivalents at December 31, 1998.
Investment Securities
Our investment securities are classified as available-for-sale and carried
at market value, with unrealized gains and losses excluded from the
consolidated statements of operations and reported in other comprehensive
income
F-7
<PAGE>
(loss). Realized gains and losses on the sales of investment securities are
determined on the specific identification method and included in investment
income, net.
Investment in Affiliate
In 1999, we acquired approximately 20% of the issued share capital of
PulmoPharm GmbH, a distributor of pharmaceutical products in Germany. This
investment is included in other assets and is accounted for using the
equity method. Accordingly, the investment is recorded at cost, adjusted
for our share of income or losses of the entity.
Inventories
Inventories are stated at the lower of cost, as determined by the first-in,
first-out method, or market.
Depreciation and Amortization
Improvements, furniture and equipment are depreciated using the straight-
line method over the assets' estimated useful lives of 5 to 10 years.
Leasehold improvements are amortized using the straight-line method over
the shorter of the assets' estimated useful lives or the remaining term of
the lease. Our building in England is depreciated using the straight-line
method over its estimated useful life of 40 years.
Revenues
Product sales are recognized upon shipment. We perform ongoing credit
evaluations of our customers and generally do not require collateral.
Product sales are recorded net of reserves for estimated chargebacks,
returns, discounts and rebates. Allowances for discounts, returns, bad
debts, chargebacks and rebates, which are netted against accounts
receivable, totaled $3,187,373 and $1,550,864 at December 31, 1999 and
1998, respectively.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial
Statements, which must be applied in the first quarter of 2000. SAB No. 101
provides guidance on revenue recognition issues. We do not expect that the
adoption of SAB No. 101 will have a current impact on our financial
statements.
Translation of Foreign Currencies
The financial statements of our subsidiaries are translated from local
currency into U.S. dollars using the current exchange rate at the balance
sheet date for assets and liabilities, and the average exchange rate
prevailing during the period for revenues and expenses. The local currency
is considered to be the functional currency for each entity and
accordingly, translation adjustments for these subsidiaries are included as
a component of accumulated other comprehensive income or loss in
stockholders' equity. Transaction gains and losses are recorded in other
income (expense) and were insignificant in 1999 and 1998.
Research and Development Costs
Research and development costs are charged to expense as incurred.
Income Taxes
Deferred income taxes are provided based on the estimated future tax
effects of temporary differences between financial statement carrying
amounts of existing assets and liabilities and their respective tax bases
and for net operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
that are expected to apply to taxable income in the years in which those
temporary differences and carryforwards are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the
F-8
<PAGE>
period that includes the enactment date. A valuation allowance is
established when necessary to reduce deferred tax assets to the amount
expected to be realized.
Fair Value of Financial Instruments
Our financial instruments other than investments consist of cash and cash
equivalents, accounts receivable, interest receivable, accounts payable and
a contract payable. The fair value of these financial instruments
approximates their carrying amount due to their short-term nature or
current market indicators.
Comprehensive Income (Loss)
Comprehensive income (loss) consists of net income (loss) and other gains
and losses affecting stockholders' equity that, under generally accepted
accounting principles, are excluded from net income (loss). These include
unrealized gains or losses on available-for-sale securities and foreign
currency translation adjustments. Unrealized gain (loss) on investment
securities included in comprehensive income (loss) for 1999 and 1998 is net
of the reclassification adjustment for losses included in net income (loss)
of approximately $72,000 and $24,700, respectively.
Business Segments
In 1998, we adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. SFAS No. 131 requires an enterprise to
report segment information based on how management internally evaluates the
operating performance of its business units (segments). Our operations are
confined to one business segment, the development of drugs to treat chronic
infectious diseases.
Stock-Based Compensation
We account for stock option plans for employees in accordance with the
provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations. As such,
compensation expense related to employee stock options is recorded if, on
the date of grant, the fair value of the underlying stock exceeds the
exercise price. We apply the disclosure-only requirements of SFAS No. 123,
Accounting for Stock-Based Compensation, which allows entities to continue
to apply the provisions of APB Opinion No. 25 for transactions with
employees, and to provide pro forma results of operations disclosures for
employee stock option grants made in 1995 and subsequent years as if the
fair-value-based method of accounting in SFAS No. 123 had been applied to
those transactions.
Income (Loss) Per Share
Basic income (loss) per share is computed on the basis of the weighted
average number of shares of common stock outstanding for the year. Diluted
income (loss) per share is computed on the basis of the weighted average
number of shares of common stock plus dilutive potential shares outstanding
using the treasury stock method. Potential dilutive shares of common stock
consist of shares issuable to holders of unexercised employee stock options
and warrants outstanding.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
F-9
<PAGE>
Impairment of Long-Lived Assets
We review our long-lived assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows
expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of the assets exceeds the fair value of the
assets. Assets to be disposed of are reported at the lower of their
carrying amount or fair value less costs to sell.
(2) Investment Securities
The following summarizes our investment securities at December 31:
<TABLE>
<CAPTION>
Gross Gross
unrealized unrealized Market
Amortized cost gains losses value
------------------- --------------- --------------- ------------------
<S> <C> <C> <C> <C>
1999:
U.S. Treasury notes $ 913,453 $ -- $ (10,078) $ 903,375
Federal mortgage notes 2,874,782 816 (31,197) 2,844,401
Corporate obligations 31,056,356 9,343 (263,737) 30,801,962
------------------- --------------- --------------- ------------------
$ 34,844,591 $ 10,159 $ (305,012) $ 34,549,738
=================== =============== =============== ==================
1998:
Federal mortgage notes $ 2,629,558 $ 12,350 $ (4,034) $ 2,637,874
Municipal bonds 452,362 52 -- 452,414
Corporate obligations 43,653,353 182,268 (57,519) 43,778,102
------------------- --------------- --------------- ------------------
$ 46,735,273 $ 194,670 $ (61,553) $ 46,868,390
=================== =============== =============== ==================
</TABLE>
Amortized cost and market value of investment securities at December 31,
1999, by contractual maturity are shown below. Actual maturities may differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Amortized Market
Maturities cost value
---------------------- -----------------------
<S> <C> <C>
Due in 1 year or less $ 9,810,325 $ 9,748,786
Due between 1 year to 5 years 19,045,123 18,857,186
Due between 5 years to 10 years 1,818,355 1,809,653
Due after 10 years 4,170,788 4,134,113
---------------------- -----------------------
$ 34,844,591 $ 34,549,738
====================== =======================
</TABLE>
Investment income, net includes interest of $2,849,838, $4,098,440, and
$5,216,693 earned on investments and gains (losses) of $(143,099),
$(42,619) and $61,405 realized upon the sale of investments for 1999, 1998
and 1997, respectively.
F-10
<PAGE>
(3) Inventories
Inventories consisted of the following at December 31:
<TABLE>
<CAPTION>
1999 1998
--------------- ---------------
<S> <C> <C>
Finished goods $ 2,433,718 $ 4,174,206
Work in progress 2,907,128 2,747,380
Raw materials and supplies 9,272,539 2,986,330
--------------- ---------------
$ 14,613,385 $ 9,907,916
=============== ===============
</TABLE>
(4) License Agreement
Effective September 30, 1998, we entered into a license agreement with
Bristol-Myers Squibb to obtain exclusive worldwide rights to PA-1806, a
patented chemical compound in the monobactam class of antibiotics.
PathoGenesis obtained the rights to PA-1806 for inhaled, non-systemic
administration of the compound for the treatment or prophylaxis of
respiratory tract infectious diseases. The initial payment obligation for
this license of $4.0 million was charged to expense as license fee in 1998.
Payment of $2.0 million was made in October 1998, with the $2.0 million
balance paid in January 1999. Subsequent payments totaling $4.0 million
could be made upon accomplishment of certain milestones. We will pay a
royalty on net sales of products using the chemical compound.
(5) Acquisition of License Rights
In 1994, we entered into license agreements with the Cystic Fibrosis
Foundation and another party to obtain worldwide rights to TOBI. Pursuant
to our license agreement with the foundation, we were required to make
royalty payments of 2.5% on net product sales through the patent expiration
date of TOBI. In 1998, we acquired the foundation's rights in TOBI for
payments totaling $16.0 million, to be made in three equal annual
installments.
The purchase amount has been recorded on our consolidated balance sheet at
the net present value of the required cash payments, using a discount rate
of 9%. The value of the license rights is being amortized to cost of sales
over the remaining life of the TOBI patent. Accumulated amortization
totaled $1,123,939 and $153,131 at December 31, 1999 and 1998,
respectively.
A corresponding discounted liability has been recorded for the remaining
installment payment obligation to the foundation. The discount is being
amortized to interest expense over the installment term, using the
effective interest method. The $5,333,333 portion of the purchase price
payable after December 31, 1999 is secured by an irrevocable standby letter
of credit issued by a bank. This letter of credit is secured by our
investment securities.
(6) Stockholders' Equity
Common Stock
Effective June 25, 1997, our stockholders approved an increase in the
authorized number of shares of PathoGenesis' $0.001 par value common stock
to 60,000,000 shares.
Stock Option Plans
In 1992, we adopted the 1992 Stock Option Plan, under which 1,500,000
shares of common stock were authorized to be reserved for grants. At
December 31, 1999, 27,141 shares remained available for future
F-11
<PAGE>
awards. Options granted under that plan may be designated as qualified or
nonqualified at the discretion of the compensation and nominating committee
of the board of directors.
In 1997, we adopted the 1997 Stock Option Plan, under which 2,000,000
shares of common stock were reserved for grants. At December 31, 1999,
128,126 shares remained available for future awards. Options granted under
that plan may be designated as qualified or nonqualified at the discretion
of the compensation and nominating committee of the board of directors. A
number of options were granted in 1997 under the plan before the plan
received stockholder approval. This resulted in deferred compensation of
approximately $1,594,000, based on the excess of the fair market value of
the stock at the time of plan approval (measurement date) over the exercise
price, which was based on the fair value of the stock at the time of option
grant. Deferred compensation of approximately $201,000 was recognized in
1998 as a result of option grants to consultants. Deferred compensation is
being amortized on the straight-line method over the vesting period of the
options.
In 1999, we adopted the 1999 Employee Stock Option Plan, under which
600,000 shares of common stock were reserved for grants. At December 31,
1999, 148,100 shares remained available for future awards. Options granted
under that plan are designated as nonqualified.
In 1999, we also adopted the 1999 Stock Plan, under which 800,000 shares of
common stock were reserved for grants. At December 31, 1999, 290,000 shares
remained available for future awards. Options granted under that plan may
be designated as qualified or nonqualified at the discretion of the
compensation and nominating committee of the board of directors.
In 1996, we adopted the 1996 Directors Stock Option Plan (Directors Plan)
for nonemployee directors, under which 300,000 shares of common stock were
reserved for grants. Upon adoption of the 1997 Stock Option Plan, the
Directors Plan was terminated with no further grants to be made.
Generally, options vest over a four-year period in installments of 25% each
year beginning one year from the date of grant. However, certain options
can vest upon grant. Vested options may be exercised at any time before
their expiration date. All options expire not later than 10 years from the
date of grant. Qualified stock options are exercisable at not less than the
fair market value of the stock at the date of grant. Nonqualified stock
options are exercisable at prices determined at the discretion of the board
of directors, but not less than 85% of the fair market value of the stock
at the date of grant.
F-12
<PAGE>
A summary of stock options follows:
<TABLE>
<CAPTION>
Weighted
1999 average
1992 Directors 1997 Employee 1999 Stock exercise
Stock Plan Plan Stock Plan Stock Plan Plan price
-------------- -------------- -------------- -------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31,
1996 1,224,775 42,000 - - - $ 12.73
Granted 134,205 - 658,995 - - 26.04
Canceled (33,108) - (19,150) - - 18.52
Exercised (169,543) (8,000) - - - 12.10
-------------- -------------- -------------- -------------- -------------- -------------
Balances at December 31,
1997 1,156,329 34,000 639,845 - - 18.51
Granted - - 683,597 - - 34.95
Canceled (20,125) - (47,523) - - 27.23
Exercised (74,766) - (15,165) - - 15.28
-------------- -------------- -------------- -------------- -------------- -------------
Balances at December 31,
1998 1,061,438 34,000 1,260,754 - - 23.15
Granted - - 735,792 520,300 510,000 25.09
Canceled (3,087) - (139,837) (68,400) - 29.37
Exercised (31,044) - (6,638) - - 14.37
-------------- -------------- -------------- -------------- -------------- -------------
Balances at December 31,
1999 1,027,307 34,000 1,850,071 451,900 510,000 $ 23.78
============== ============== ============== ============== ============== =============
</TABLE>
The weighted average fair value of options granted was $13.91, $17.76 and
$14.06 in 1999, 1998 and 1997, respectively.
Had compensation cost for our stock compensation plans been determined
consistent with SFAS No. 123, our net income (loss) and income (loss) per
share would have been adjusted to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1999 1998 1997
------------------- ------------------ -----------------
<S> <C> <C> <C>
Net income (loss) - as reported $ (8,195,418) $ 1,882,901 $ (33,037,730)
Net loss - pro forma (23,976,911) (7,745,344) (38,075,062)
Income (loss) per share - as reported:
Basic (0.50) 0.12 (2.10)
Diluted (0.50) 0.11 (2.10)
Loss per share - pro forma:
Basic (1.46) (0.48) (2.42)
Diluted (1.46) (0.48) (2.42)
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used
for grants: dividend yield of 0.0% for all years; expected volatility of
59% to 83% for 1999, 56% to 59% for 1998 and 58% to 64% for 1997; risk-free
interest rate of 4.60% to 6.27% for 1999, 4.31% to 5.72% for 1998 and 5.72%
to 6.44% for 1997; expected lives from three to six years for all years.
F-13
<PAGE>
The following table summarizes information about stock options outstanding
at December 31, 1999:
<TABLE>
<CAPTION>
Total Options Exercisable Options
------------------------------------------------------------------------------ --------------------------------
Weighted
average Weighted Weighted
Range of remaining average average
exercise Number of contractual exercise Number of exercise
prices shares life price shares price
-------------------- --------------- ----------------- ------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
$ 10.00 to 19.69 2,066,152 7.6 years $ 13.54 999,690 $ 13.12
20.00 to 29.94 684,954 7.3 years 24.64 396,293 24.59
30.25 to 49.44 670,222 8.2 years 36.61 237,885 36.19
50.25 to 56.63 451,950 9.1 years 50.27 125,000 50.25
--------------- --------------
$ 10.00 to 56.63 3,873,278 7.8 years $ 23.78 1,758,868 $ 21.47
=============== ==============
</TABLE>
Common Stock Warrants
As of December 31, 1999, we had outstanding warrants, with expiration terms
ranging from April 22, 2000 to February 6, 2001, to purchase 28,223 shares
of common stock, substantially all of which are fully exercisable at $14.40
per share.
Shareholder Rights Plan
The board of directors adopted a Shareholder Rights Plan in 1997 and
declared a dividend of one right for each outstanding share of common
stock. Such rights only become exercisable after a person or group, whose
action has not received prior approval from the board of directors,
acquires beneficial ownership of, or commences a tender or exchange offer
for, 15% or more of our common stock. Each right then may be exercised to
acquire one one-thousandth of a share of preferred stock, designated as
Series A Junior Preferred Stock, at an exercise price of $250, subject to
adjustment. We may redeem the rights at $0.01 per right at any time until
the 10th day following the public announcement that a 15% position has been
acquired. The rights expire on June 26, 2007.
Employee Stock Purchase Plan
On June 3, 1998, we adopted an employee stock purchase plan, effective July
1, 1998, for all eligible employees. Under the plan, shares of PathoGenesis
common stock may be purchased at 85% of the fair market value on the
subscription date or purchase date, whichever is lower. Each subscription
has a two-year term, with share purchases made at the end of each six-month
period. The aggregate price for shares purchased by an employee may not
exceed $25,000 annually (subject to limitations imposed by the Internal
Revenue Code). The plan expires on June 30, 2008 and a total of 200,000
shares are available for purchase under the plan. We issued 63,061 shares
for employee stock purchases in 1999. At December 31, 1999, 136,939 shares
were available for purchase under the plan. Pro forma compensation expense
is recognized for the fair value of each employee stock purchase right
estimated on the date of grant using the Black-Scholes pricing model. The
following assumptions were used for employee stock purchases in 1999:
expected volatility of 58% to 84%; risk-free interest rates of 4.52% to
5.90%; expected lives of six months to two years; and zero dividend yield.
The weighted average fair value of employee stock purchase rights granted
in 1999 was $6.93.
F-14
<PAGE>
(7) Income (Loss) Per Share
The following table sets forth the computation of basic and diluted income
(loss) per share of common stock:
<TABLE>
<CAPTION>
1999 1998 1997
-------------------- --------------------- ---------------------
<S> <C> <C> <C>
Basic income (loss) per share computation:
Numerator:
Net income (loss) $(8,195,418) $ 1,882,901 $(33,037,730)
-------------------- --------------------- ---------------------
Denominator:
Weighted average common shares 16,406,734 16,265,452 15,704,151
-------------------- --------------------- ---------------------
Basic income (loss) per share $ (0.50) $ 0.12 $ (2.10)
==================== ===================== =====================
Diluted income (loss) per share computation:
Numerator:
Net income (loss) $(8,195,418) $ 1,882,901 $(33,037,730)
-------------------- --------------------- ---------------------
Denominator:
Weighted average common shares 16,406,734 16,265,452 15,704,151
Effect of dilutive securities:
Common stock warrants - 35,146 -
Stock options - 855,093 -
-------------------- --------------------- ---------------------
Dilutive potential common shares - 890,239 -
-------------------- --------------------- ---------------------
Denominator for diluted income (loss)
per Share 16,406,734 17,155,691 15,704,151
-------------------- --------------------- ---------------------
Diluted income (loss) per share $ (0.50) $ 0.11 $ (2.10)
==================== ===================== =====================
</TABLE>
Options and warrants to purchase 3,371,353, 253,705 and 2,118,198 shares of
common stock during 1999, 1998, and 1997, respectively, were not included
in the computation of diluted income (loss) per share because the
representative share increments would be antidilutive.
(8) Income Taxes
Our reported federal income taxes differ from the amounts computed by
applying the U.S. federal income tax rate of 34% to pretax income or loss
due to limitations on using net operating loss carryforwards in 1999 and
1997, and due to the utilization of net operating loss carryforwards in
1998.
The tax effects of temporary differences and carryforwards that give rise
to deferred tax assets at December 31 are as follows:
<TABLE>
<CAPTION>
1999 1998
--------------------- --------------------
<S> <C> <C>
Deferred tax assets:
Orphan drug credit carryforwards $ 5,010,532 $ 5,010,532
License agreements 186,006 1,571,066
Research and experimentation credit carryforwards 1,536,596 1,238,499
Net operating loss carryforwards 34,216,788 30,482,177
Other 2,489,415 1,482,073
--------------------- --------------------
Total gross deferred tax assets 43,439,337 39,784,347
Less valuation allowance 43,439,337 39,784,347
--------------------- --------------------
Net deferred tax assets $ -- $ --
===================== ====================
</TABLE>
F-15
<PAGE>
The valuation allowance for deferred tax assets increased by $3,654,990 and
$59,787 in 1999 and 1998, respectively. The change in 1999 is primarily
attributable to the increase in net operating loss carryforwards whose
utilization cannot be reasonably assured.
At December 31, 1999, we had net operating loss carryforwards of
approximately $100,637,000 and tax credit carryforwards of approximately
$6,548,000, which are available to offset future federal taxable income and
income taxes, respectively, if any, and expire beginning in 2007.
Approximately $6,143,000 of the net operating loss carryforwards result
from stock option deductions which, when and if realized, would result in a
credit to stockholders' equity.
(9) Lease Commitments
We lease various office and research facilities under noncancelable
operating leases which expire between 2001 and 2003.
Minimum future lease payments under noncancelable operating leases and
related sublease income as of December 31, 1999 are as follows:
<TABLE>
<CAPTION>
Lease payments Sublease income
---------------------- -----------------------
<S> <C> <C>
2000 $ 2,991,000 $ 333,000
2001 2,957,000 --
2002 1,872,000 --
2003 325,000 --
---------------------- -----------------------
$ 8,145,000 $ 333,000
====================== =======================
</TABLE>
Rent expense for operating leases was approximately $2,578,000, $2,531,000
and $2,002,000 for 1999, 1998 and 1997, respectively.
(10) Employee Benefits
As a retirement plan, we offer a defined contribution plan covering
substantially all full-time and part-time U.S. employees. The plan is a
salary deferral arrangement pursuant to Internal Revenue Code section
401(k) and is subject to the provisions of the Employee Retirement Income
Security Act of 1974. In April 1999, we began discretionary contributions
of 50% of the first 3% of compensation that a participant contributes to
the plan. We recorded expense resulting from matching contributions to the
plan of $122,251 in 1999.
(11) Facility Agreement
In February 1999, we entered into a facility agreement with Harris Trust
and Savings Bank. The agreement provides us with a $10.0 million revolving
line of credit in the form of short-term demand loans. The loans may bear
interest at floating rates based on LIBOR (London Interbank Offering Rate),
the bank's prime commercial rate or a combination of both, and may be
converted from one basis to another from time to time in accordance with
the terms of the agreement. The credit facility, subject to annual review,
will be available to us on an uncommitted basis. We have not drawn funds
under this facility agreement to date.
(12) Subsequent Events
Collaboration and Investment Agreements
In January 2000, we entered into a collaboration with Chiron Corporation to
discover and develop new antibiotics. The collaboration combines Chiron's
combinatorial chemistry library and expertise in high-throughput screening
with our strengths in bacterial target discovery and antibiotic
development, as well as our knowledge of the P. aeruginosa genome. The
focus of this collaboration is on the discovery of novel treatments
F-16
<PAGE>
for infectious diseases, specifically antibiotics with new mechanisms of
action to address serious medical needs, such as antibiotic resistance.
In March 2000, we entered into an agreement with AeroGen, Inc. to
collaborate on the development and registration of a product combining TOBI
and AeroGen's hand-held, portable AeroDose(TM) Inhaler. Our goal is to
reduce TOBI's delivery time from 15-20 minutes to 5-10 minutes or less.
Under the development and supply agreement, we will reimburse AeroGen for
costs incurred in developing the AeroDose Inhaler and will obtain worldwide
exclusive distribution rights to the product. AeroGen will receive
royalties on all product sales. Under a separate agreement, we invested
$2.5 million in the convertible preferred stock of privately held AeroGen.
This investment will be accounted for under the cost method.
Legal Proceedings
On February 18, 2000, the United States District Court for the Western
District of Washington dismissed with prejudice all eight consolidated
putative class action lawsuits that had been filed in March and April 1999
against PathoGenesis Corporation, our chief executive officer and our chief
financial officer. The eight consolidated lawsuits (Lipton v. PathoGenesis
et al., C99-0419; Green v. PathoGenesis et al., C99-0439; Gellert v.
PathoGenesis et al., C99-0452; May v. PathoGenesis et al., C99-0453;
Shapiro v. PathoGenesis et al., C99-0455; Bassin v. PathoGenesis et al.,
C99-0469; Barker v. PathoGenesis et al., C99-0503; and Kralovk v.
PathoGenesis et al., C99-0506) purported to allege claims on behalf of all
purchasers of PathoGenesis common stock during the period January 15, 1999
to March 22, 1999. Plaintiffs had claimed that the company and the officers
violated certain provisions of the federal securities laws by making
statements in early 1999 regarding the company's 1998 financial results.
The court's order dismissed the consolidated cases and bars plaintiffs from
filing another lawsuit on the matter. Plaintiffs have appealed the
dismissal order to the United States Court of Appeals for the Ninth
Circuit. We intend to defend the appeal vigorously. Although we cannot
ascertain the ultimate outcome of the appeal at this time or predict with
certainty the results of legal proceedings, we currently believe that the
resolution of the appeal will not have a material adverse effect on our
financial position or results of operations.
(13) Quarterly Financial Information (Unaudited)
(in thousands, except per share data)
<TABLE>
<CAPTION>
1999 Quarters First Second Third Fourth
-------------- -------------- -------------- -----------------
<S> <C> <C> <C> <C>
Revenues $ 10,260 $ 14,301 $ 16,461 $ 19,822
Net loss (4,738) (2,500) (783) (175)
Loss per share - basic and diluted $ (0.29) $ (0.15) $ (0.05) $ (0.01)
Weighted average common shares 16,379 16,394 16,405 16,448
outstanding - basic and diluted
<CAPTION>
1998 Quarters First Second Third Fourth
-------------- -------------- -------------- -----------------
Revenues $ 14,665 $ 13,650 $ 14,901 $ 17,836
Net income (loss) 985 982 (3,002) 2,919
Income (loss) per share - basic $ 0.06 $ 0.06 $ (0.18) $ 0.18
Income (loss) per share - diluted $ 0.06 $ 0.06 $ (0.18) $ 0.17
Weighted average common shares 16,243 16,253 16,264 16,302
outstanding - basic
Weighted average common shares 17,146 17,096 16,264 17,456
outstanding - diluted
</TABLE>
F-17
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Seattle, State of Washington, on March 28, 2000.
PATHOGENESIS CORPORATION
By: /s/ Wilbur H. Gantz
------------------------------------
Wilbur H. Gantz
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title
--------- -----
<S> <C>
/s/ Wilbur H. Gantz Chairman, Chief Executive )
- ------------------------------------------------- Officer, President and )
Wilbur H. Gantz Director (Principal Executive )
Officer) )
)
/s/ Alan R. Meyer Executive Vice President, )
- ------------------------------------------------- Chief Financial Officer and )
Alan R. Meyer Director (Principal Financial )
and Accounting Officer) )
)
/s/ John L. Gordon Director )
- ------------------------------------------------- )
John L. Gordon )
)
)
/s/ Elizabeth Greetham Director )
- ------------------------------------------------- )
Elizabeth Greetham ) March 28, 2000
)
)
/s/ Michael J. Montgomery Director )
- ------------------------------------------------- )
Michael J. Montgomery )
)
)
/s/ Arthur W. Nienhuis Director )
- ------------------------------------------------- )
Arthur W. Nienhuis )
)
)
/s/ Talat M. Othman Director )
- ------------------------------------------------- )
Talat M. Othman )
)
)
/s/ Eugene L. Step Director )
- ------------------------------------------------- )
Eugene L. Step )
)
)
/s/ James R. Tobin Director )
- ------------------------------------------------- )
James R. Tobin )
)
)
/s/ Fred Wilpon Director )
- ------------------------------------------------- )
Fred Wilpon )
</TABLE>
S-1
<PAGE>
EXHIBIT INDEX
No. Description of Exhibit
- --------- ------------------------------------------------------------------
3.1(a) Amended and Restated Certificate of Incorporation, as amended
(incorporated by reference to Exhibit 3.1 to the Company's
Registration Statement on Form S-1, Registration No. 333-22297).
3.1(b) Certificate of Amendment of Amended and Restated Certificate of
Incorporation (incorporated by reference to Exhibit 4.1(b) to the
Company's Registration Statement on Form S-8, Registration No.
333-45571).
3.1(c) Certificate of Designations (incorporated by reference to Exhibit
4.3 to the Company's Registration Statement on Form S-8,
Registration No. 333-45571).
3.1(d) Composite Certificate of Incorporation, as amended (incorporated
by reference to Exhibit 3.1(d) to the Company's Quarterly Report
on Form 10-Q for the Three Months Ended March 31, 1998, Commission
File No. 027150).
3.2 By-Laws, as amended through June 3, 1999 (incorporated by
reference to Exhibit 3.2 to the Company's Quarterly Report on Form
10-Q for the Three Months Ended June 30, 1999, Commission File No.
027150).
4.1(a) Form of Stock Certificate (incorporated by reference to Exhibit
4.1 to the Company's Registration Statement on Form S-1,
Registration No. 33-97070).
4.1(b) Rights Agreement dated as of June 25, 1997 between the Company and
Harris Trust and Savings Bank, as Rights Agent, including the form
of Right Certificate as Exhibit B (incorporated by reference to
Exhibit 1 to the Company's Current Report on Form 8-K filed on
July 10, 1997, Commission File No. 027150).
4.1(bb) First Amendment, dated as of March 8, 1998, to Rights Agreement
between the Company and Harris Trust and Savings Bank, as Rights
Agent (incorporated by reference to Exhibit 4.1(bb) to the
Company's Annual Report on Form 10-K for 1997, Commission File No.
027150).
4.1(bbb) Amendment, dated as of April 13, 1999, to Rights Agreement between
the Company and Harris Trust and Savings Bank, as Rights Agent
(incorporated by reference to Exhibit 1 to the Company's Current
Report on Form 8-K filed on April 15, 1999, Commission File No.
027150).
4.1(c) Form of Right (included in Exhibit 4.1(b)).
4.2 PathoGenesis Corporation 1992 Stock Option Plan (incorporated by
reference to Exhibit 4.2 to the Company's Registration Statement
on Form S-1, Registration No. 33-97070).
4.3 1996 Non-Employee Director Plan (incorporated by reference to
Exhibit 4.3 to the Company's Annual Report on Form 10-K for 1995,
Commission File No. 027150).
4.4 PathoGenesis Corporation 1997 Stock Option Plan (incorporated by
reference to Appendix A to the Company's Proxy Statement dated
April 29, 1997, Commission File No. 027150).
4.5 PathoGenesis Corporation 1999 Employee Stock Option Plan
(incorporated by reference to Exhibit 4.5 to the Company's
Quarterly Report on Form 10-Q for the Three Months Ended March 31,
1999, Commission File No. 027150).
4.6 PathoGenesis Corporation 1999 Stock Plan (incorporated by
reference to Appendix A to the Company's proxy statement dated
April 19, 1999, Commission File No. 027150).
4.8 Form of Stock Option Agreement for 1997 Stock Option Plan
(incorporated by reference to Exhibit 4.8 to the Company's
Quarterly Report on Form 10-Q for the Three Months Ended June 30,
1999, Commission File No. 027150).
4.9 Form of Stock Option Agreement for 1999 Employee Stock Option Plan
(incorporated by reference to Exhibit 4.9 to the Company's
Quarterly Report on Form 10-Q for the Three Months Ended June 30,
1999, Commission File No. 027150).
1
<PAGE>
No. Description of Exhibit
- --------- ------------------------------------------------------------------
4.10 Form of Stock Option Agreement for 1999 Stock Plan (incorporated
by reference to Exhibit 4.10 to the Company's Quarterly Report on
Form 10-Q for the Three Months Ended June 30, 1999, Commission
File No. 027150).
4.11 PathoGenesis Corporation Employee Stock Purchase Plan
(incorporated by reference to Appendix A to the Company's Proxy
Statement dated April 20, 1998, Commission File No. 027150).
4.12(a) PathoGenesis Corporation 401(k) Profit Sharing Plan (incorporated
by reference to Exhibit 4.6 to the Plan's Registration Statement
on Form S-8, Registration No. 333-63679).
4.12(b) Trust Agreement, dated as of April 1, 1998, between the Company
and Wilmington Trust Company, as Trustee (incorporated by
reference to Exhibit 4.7 to the Plan's Registration Statement on
Form S-8, Registration No. 333-63679).
10.3 Form of Employment Agreement between the Company and A. Bruce
Montgomery, dated September 19, 1995 (incorporated by reference to
Exhibit 10.2 to the Company's Registration Statement on Form S-1,
Registration No. 33-97070).
10.4 Employment Agreement between the Company and Marc F. Wipperman,
effective as of July 1, 1996 (incorporated by reference to Exhibit
10.4 to the Company's Registration Statement on Form S-1,
Registration No. 333-22297).
10.11 Licensing Agreement between the Company and Kaneka Corporation,
dated October 25, 1993 and amendment thereto, dated March 3, 1995
(incorporated by reference to Exhibit 10.9 to the Company's
Registration Statement on Form S-1, Registration No. 33-97070).*
10.12 Supply Agreement between the Company and Kaneka Corporation, dated
as of October 25, 1993 (incorporated by reference to Exhibit 10.10
to the Company's Registration Statement on Form S-1, Registration
No. 33-97070).*
10.16 License Agreement between the Company and Children's Hospital and
Medical Center, dated January 1, 1994 (incorporated by reference
to Exhibit 10.14 to the Company's Registration Statement on Form
S-1, Registration No. 33-97070).*
10.17 License Agreement between the Company and the Cystic Fibrosis
Foundation, dated January 1, 1994 (incorporated by reference to
Exhibit 10.15 to the Company's Registration Statement on Form S-1,
Registration No. 33-97070).*
10.21(a) Lease for laboratory in Seattle, Washington, between David A.
Sabey and Sandra L. Sabey and the Company, dated June 8, 1992 (the
"Laboratory Lease"), as amended by the Second Amendment, dated
November 16, 1992 (incorporated by reference to Exhibit 10.18 to
the Company's Registration Statement on Form S-1, Registration No.
33-97070).
10.21(b) Third Amendment to the Laboratory Lease, dated August 1, 1996
(incorporated by reference to Exhibit 10.21 to the Company's
Registration Statement on Form S-1, Registration No. 333-22297).
10.23(a) Lease for the Skokie, Illinois facility, between The Equitable
Life Assurance Society of the United States and the Company, dated
October 1992 (the "Skokie Lease"), as amended, dated March 31,
1995 (incorporated by reference to Exhibit 10.20 to the Company's
Registration Statement on Form S-1, Registration No. 33-97070).
10.23(b) Amendment to Skokie Lease, dated April 30, 1996 (incorporated by
reference to Exhibit 10.23 to the Company's Registration Statement
on Form S-1, Registration No. 333-22297).
10.24 Lease for Annandale, New Jersey Facility, between Exxon Research
and Engineering Company and the Company, dated November 25, 1996
(incorporated by reference to Exhibit 10.24 to the Company's
Registration Statement on Form S-1, Registration No. 333-22297).
2
<PAGE>
No. Description of Exhibit
- --------- ------------------------------------------------------------------
10.25 Rights Agreement dated as of June 25, 1997 between PathoGenesis
Corporation and Harris Trust and Savings Bank, as Rights Agent,
including the form of Right Certificate as Exhibit B, First
Amendment to Rights Agreement, dated as of March 8, 1998 and
Amendment dated as of April 13, 1999 (included in Exhibits 4.1(b),
4.1(bb) and 4.1(bbb)).
10.26 1992 Stock Option Plan (included in Exhibit 4.2).
10.27 1996 Non-Employee Director Plan (included in Exhibit 4.3).
10.28 1997 Stock Option Plan and related Form of Stock Option Agreement
(included in Exhibits 4.4 and 4.8).
10.29 Processing Services Agreement dated as of May 5, 1998, between
PathoGenesis Corporation and Automatic Liquid Packaging, Inc.
(incorporated by reference to Exhibit 10.29 to the Company's
Quarterly Report on Form 10-Q for the Three Months Ended March 31,
1998, Commission File No. 0-27150).*
10.30 Agreement dated as of May 29, 1998, between PathoGenesis
Corporation and the Cystic Fibrosis Foundation (incorporated by
reference to Exhibit 10.30 to the Company's Quarterly Report on
Form 10-Q for the Three Months Ended June 30, 1998, Commission
File No. 0-27150).
10.31 License Agreement between Bristol-Myers Squibb Company and
PathoGenesis Corporation dated September 30, 1998 (incorporated by
reference to Exhibit 10.31 to the Company's Quarterly Report on
Form 10-Q for the Three Months Ended September 30, 1998,
Commission File No. 0-27150).*
10.32 Form of Change in Control Employment Agreement for certain key
employees (incorporated by reference to Exhibit 10.32 to the
Company's Quarterly Report for the Three Months Ended June 30,
1999, Commission File No. 0-27150).
10.33 Facility Agreement dated as of February 22, 1999 between
PathoGenesis Corporation and Harris Trust and Savings Bank
(incorporated by reference to Exhibit 10.33 to the Company's
Annual Report on Form 10-K for 1998, Commission File No. 0-27150).
10.34 1999 Employee Stock Option Plan and related Form of Stock Option
Agreement (included in Exhibits 4.5 and 4.9).
10.35 1999 Stock Plan and related Form of Stock Option Agreement
(included in Exhibits 4.6 and 4.10).
10.36 PathoGenesis Corporation Employee Stock Purchase Plan (included in
Exhibit 4.11).
10.37 PathoGenesis Corporation 401(k) Profit Sharing Plan and related
Trust Agreement (included in Exhibits 4.12(a) and 4.12(b)).
23.1 Consent of KPMG LLP.
27.1 Financial Data Schedule.
99.1 Important Information on Forward-Looking Statements.
* Contains confidential material omitted and filed separately with the
Securities and Exchange Commission. Brackets denote such omissions.
3
<PAGE>
Exhibit 23.1
Consent of Independent Certified Public Accountants
The Board of Directors
PathoGenesis Corporation:
We consent to incorporation by reference in the registration statements (Nos.
333-87615, 333-87613, 333-05095, 333-45571, 333-61183 and 333-63679) on Form S-8
of PathoGenesis Corporation of our reports dated January 21, 2000, except as to
note 12 which is as of March 23, 2000, relating to the consolidated balance
sheets of PathoGenesis Corporation and subsidiaries as of December 31, 1999 and
1998, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the years in the three-year period ended
December 31, 1999, and the related consolidated financial statement schedule for
the years ended December 31, 1999 and 1998, which reports appear in the December
31, 1999 Annual Report on Form 10-K of PathoGenesis Corporation.
KPMG LLP
Seattle, Washington
March 27, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF PATHOGENESIS CORPORATION FOR THE YEAR ENDED
DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 10,456,031
<SECURITIES> 34,549,738
<RECEIVABLES> 6,038,299
<ALLOWANCES> 0<F1>
<INVENTORY> 14,613,385
<CURRENT-ASSETS> 68,210,739
<PP&E> 31,169,265
<DEPRECIATION> 12,957,926
<TOTAL-ASSETS> 100,836,918
<CURRENT-LIABILITIES> 14,422,462
<BONDS> 0
0
0
<COMMON> 16,452
<OTHER-SE> 86,398,004
<TOTAL-LIABILITY-AND-EQUITY> 100,836,918
<SALES> 60,052,486
<TOTAL-REVENUES> 60,844,225
<CGS> 11,239,170
<TOTAL-COSTS> 70,801,299
<OTHER-EXPENSES> 318,356
<LOSS-PROVISION> 0<F2>
<INTEREST-EXPENSE> 626,727
<INCOME-PRETAX> (8,195,418)
<INCOME-TAX> 0
<INCOME-CONTINUING> (8,195,418)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,195,418)
<EPS-BASIC> (.50)
<EPS-DILUTED> (.50)
<FN>
<F1>THE AMOUNT OF RECEIVABLES REPORTED IS NET OF $3,187,373 OF ALLOWANCES.
<F2>THE TOTAL COSTS INCLUDE LOSS PROVISION OF $160,328.
</FN>
</TABLE>
<PAGE>
EXHIBIT 99.1
Important Information on Forward-Looking Statements
Our annual report on Form 10-K, news releases and other public documents,
as well as oral statements that we may make, contain "forward-looking
statements" in addition to historical information. These forward-looking
statements include statements concerning our anticipated product development
program, financial and product performance, and other non-historical events. You
may identify these forward-looking statements by the use of such words as
"believe," "anticipate," "expect," "plan" and "intend." Since these forward-
looking statements are subject to known and unknown risks and uncertainties,
they do not necessarily indicate what our actual future results will be. You
should regard all cautionary statements made in this annual report on Form 10-K
as being applicable to all related forward-looking statements wherever they
appear.
Below, we identify some important factors that may cause our actual
results, performance or achievements to be materially different from any future
results, performance or achievements expressed or implied by such forward-
looking statements.
(i) We have a limited operating history and we may not be profitable in the
future.
We began the commercial sale of our first drug product, TOBI, in January
1998. Before then, we had no sources of operating revenues from any of our drug
candidates and limited sources of revenue from grants and royalties. We had an
accumulated deficit of $107,135,680 as of December 31, 1999. Our future
profitability will depend on, among other things, the success of TOBI and our
ability to develop and market other products. In addition, because of our
limited sales experience with TOBI, we may be unable to predict or assess the
effect of seasonality, weather, medical reimbursement programs, price changes,
business cycles, national or geographic healthcare matters, wholesaler ordering
patterns, patient use patterns, and similar factors affecting sales patterns and
volatility. There can be no assurance that one or more of the factors discussed
below, or other, unforeseen factors, will not adversely affect our future
operating results and financial condition.
(ii) We currently depend solely on revenues from TOBI sales to fund our
development of additional drug products.
We do not expect our drug candidates other than TOBI to be commercially
available for at least several years. We may not be successful in developing
other drug products commercially. Meanwhile, we must depend on revenues
generated from TOBI sales to fund our product development program. However,
market acceptance of TOBI for cystic fibrosis may remain level or even decline
under certain circumstances, such as competition from alternative therapies or
adverse pricing changes. See "Third party reimbursement and product pricing
affect market acceptance of our products" and "We have many competitors." We
have seven years of marketing exclusivity for TOBI in the U.S. from the time of
TOBI's approval in December 1997. However, tobramycin also has been approved by
the FDA for intravenous and intrathecal (injection into spinal fluid)
administration. These generic formulations of tobramycin can be modified by
pharmacists, physicians or patients for inhalation. Although this practice is
not approved by the FDA, it may continue and may have a material adverse effect
on reimbursement levels, sales and market acceptance of TOBI. Furthermore, we
could incur substantial costs in asserting any rights to prevent such uses under
the Orphan Drug Act. See "Our success depends on our ability to protect patents
and proprietary technology."
(iii) Third party reimbursement and product pricing affect market acceptance of
our products.
One factor that may significantly affect how successfully we can
commercialize our products is the extent to which reimbursement for the cost of
such products will be available from third party payors, such as private health
insurers or Medicaid in the U.S. Adequate reimbursement in the U.S. or other
countries may not be available for any products we have developed or will
develop. If government and third-party payors do not provide adequate coverage
and reimbursement for use of our products, the market acceptance of those
products would be likely to decline.
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<PAGE>
(iv) International markets involve additional risks.
We or our distributors recently began marketing TOBI in Canada, Argentina,
the U.K. and Israel, and we intend to market TOBI in other international markets
as soon as we have received the appropriate regulatory approvals. In addition to
the same risks in the U.S. market, we face certain risks unique to international
operations. The prices of our products may be restricted by price controls
imposed by local governments and healthcare providers in some countries. Price
controls can cause significant differences in prices between different markets.
The existence of price controls can limit the revenues from sales of our
products outside the U.S. and may adversely affect our business and results of
operations. Currency fluctuations also may cause or aggravate the adverse
effects.
(v) We have limited sales and marketing capabilities.
Our sales, marketing and distribution capabilities in the U.S. were
established relatively recently in anticipation of TOBI's launch in 1998. We are
establishing sales, marketing and distribution capabilities in other countries
where we have received, or expect to receive in the near future, regulatory
approval to market TOBI. As a company, we have limited experience in these
areas. These capabilities may not be sufficient or successful for the longer
term.
(vi) We have only limited manufacturing capability and we are dependent on
suppliers.
We rely on others to supply raw materials and to manufacture TOBI according
to regulatory requirements. Although we believe either one of our two suppliers
of bulk powdered tobramycin will be able to supply sufficient quantities to meet
our current needs, we have not entered into long-term supply contracts with the
suppliers. We have an agreement for the formulation and packaging of TOBI for a
minimum term of 10 years. There can be no assurance that we will be able to
obtain future supplies of bulk tobramycin on favorable terms, that contract
manufacturers will be able to provide us with sufficient quantities of TOBI, or
that the products supplied will meet specifications.
(vii) Our success depends on our ability to protect patents and proprietary
technology.
Our ability to compete effectively depends on our ability to protect our
proprietary technology in the U.S. and internationally, preserve our trade
secrets and know-how, and maintain technological advantages. We intend to file
applications as appropriate for patents covering formulation, composition of
matter, uses of our drug candidates, our proprietary processes and any
significant gene sequences that our scientists discover. We can incur
substantial costs in proceedings before the U.S. Patent and Trademark Office and
other regulatory authorities, and we may not obtain any patents we apply for.
Even if obtained, these patents may be challenged, invalidated or circumvented,
or may not provide any competitive advantage. We also rely on trade secrets,
know-how and other unpatented proprietary information in our business. We have
entered into confidentiality and invention agreements with our employees and
consultants, but there can be no assurance that each of these agreements will be
honored. Moreover, we may not be able to effectively protect our patents or our
rights to unpatented trade secrets, or others may independently develop
substantially equivalent proprietary information.
(viii) We are subject to substantial government regulations and our products
are subject to regulatory approval.
Our research, clinical trials, drug production and marketing are subject to
regulation by numerous governmental agencies in the U.S. and other countries.
The effect of government regulation, or a change in the regulations, may be to
increase product development costs, delay marketing of our proposed products, or
give a competitive advantage to our competitors. Regulatory authorities may not
approve any products we develop on a timely basis or at all. In addition,
noncompliance with regulatory requirements could result in fines, injunctions,
seizures of products, total or partial suspension of product marketing,
withdrawal of marketing approvals, or criminal prosecution, among other
outcomes. Compliance with regulations may be burdensome.
2
<PAGE>
(ix) Our drug development efforts and clinical trials may not be successful.
Before approving a drug for commercial sale as a treatment for a disease,
the FDA and other regulatory authorities generally require that the safety and
efficacy of the drug be supported by results from clinical trials. Certain of
those authorities may require post-marketing testing and surveillance. Results
of initial studies of drug candidates are not necessarily indicative of results
that will be obtained from subsequent or more extensive preclinical and clinical
testing or long-term efficacy studies. Adverse or inconclusive clinical trial
results could significantly delay regulatory filings or result in a filing for a
narrower indication. There can be no assurance that our research and
development, preclinical testing, clinical trials, or long-term safety and
efficacy studies will be successfully completed or, if completed, will have the
desired results. We may not obtain regulatory approvals or may obtain approvals
that are not as broad as sought. Even if we succeed in obtaining the desired
regulatory approval for a drug, we may not be able to produce the drug
candidates in commercial quantities at reasonable costs. Furthermore, products
may not achieve market acceptance.
(x) Technological change may render our products noncompetitive or obsolete.
The pharmaceutical business is characterized by extensive research efforts
and rapid technological progress. New developments in molecular biology,
medicinal pharmacology, and other fields are expected to continue at a rapid
pace in academia and industry. Research and discoveries by others may render
some or all of our programs or drug candidates noncompetitive or obsolete.
(xi) We have many competitors.
Many companies, including well-known pharmaceutical companies, chemical
companies and specialized genetic engineering companies, are engaged in
developing pharmaceuticals for human therapeutic applications. Many of these
companies have substantially greater financial, research and development,
manufacturing, marketing and human resources than we have and represent
significant competition. Such companies may succeed in developing products that
are more effective or less costly than any that we may develop and also may be
more successful in manufacturing and marketing.
(xii) We are exposed to product liability risks which may exceed our existing
coverage.
Our business exposes us to potential product liability risks that are
inherent in the testing, manufacturing and marketing of human therapeutic
products. We maintain insurance against product liability and defense costs in
the amount of $25 million per occurrence and $25 million in the aggregate. There
can be no assurance that product liability claims will not occur, that we will
be able to obtain or maintain product liability insurance on acceptable terms,
or that such insurance will provide adequate coverage against any potential
claims.
(xiii) Our use of hazardous materials subjects us to environmental regulations.
Our research and development involve the controlled use of hazardous,
infectious and radioactive materials. We are subject to stringent federal, state
and local laws, rules, regulations and policies governing the use, generation,
manufacture, storage, air emission, effluent discharge, handling and disposal of
certain materials and wastes. We may incur significant costs to comply with
environmental laws, rules, regulations and policies. Our business, financial
position or results of operations may be materially and adversely affected by
current or future environmental laws, rules, regulations and policies or by any
releases or discharges of materials which could be hazardous. We do not maintain
a separate insurance policy to cover the risk of accidental injury or
contamination from these materials.
(xiv) We depend on our key personnel and attracting qualified personnel.
In view of the intense competition for qualified personnel in the
pharmaceutical field, we may not be able to continue to attract and retain the
qualified personnel necessary for the development of our business. The
unexpected loss of the services of existing personnel, as well as the failure to
recruit additional key scientific, technical and managerial personnel in a
timely manner, would be detrimental to our programs and business.
3
<PAGE>
(xv) We depend on some collaborative relationships with third parties and those
third parties may not continue to work with us.
Our strategy for the research, development and commercialization of our
drug candidates and proprietary technologies may require us to enter into
various arrangements with corporate and academic collaborators, licensors,
licensees and others. There can be no assurance that any revenues or profits
will be derived from such arrangements, or that we will be able to enter into
collaboration arrangements with others in the future.
(xvi) Our stock price has been volatile.
The market price of our common stock has fluctuated significantly, and is
likely to do so in the future, as is typical for publicly traded emerging
pharmaceutical companies. Factors such as results of clinical trials,
announcements of new products by PathoGenesis or our competitors, regulatory
actions, developments or disputes concerning patent or proprietary rights and
period-to-period fluctuations in our financial results could have a significant
impact on the market price of the common stock.
(xvii) Our continued access to capital is not assured.
We may need to raise substantial additional capital to fund future
operations. We may seek such additional funding through public or private
financings or collaborative, licensing and other arrangements with corporate
partners. If additional funds are raised by issuing equity securities, dilution
to existing shareholders will result and future investors may be granted rights
superior to those of existing shareholders. There can be no assurance, however,
that additional financing will be available to us on acceptable or affordable
terms when needed.
(xviii) We are subject to litigation risks.
We are a party to various lawsuits and claims arising in the ordinary
course of business or otherwise from time to time. Litigation brought against
PathoGenesis could have a material adverse effect on the company by disrupting
operations, distracting management, affecting employee morale, and resulting in
costs or liabilities not covered or not fully covered by applicable insurance.
(xix) Provisions in our corporate charter and our corporate structure may have
the effect of delaying, deferring or preventing takeover transactions.
Certain provisions of our Certificate of Incorporation and by-laws may have
the effect of delaying, deferring or preventing a change in control of the
company, even if such a change would be beneficial to many shareholders. These
provisions include a staggered board and super-majority shareholder vote for a
change in the number of directors below the minimum or the maximum established
in the by-laws. In addition, the board has the authority, without further action
by the shareholders, to issue up to one million shares of preferred stock in one
or more series and to fix their rights, preferences, privileges and
restrictions, and to issue authorized but unissued shares of common stock. The
issuance of preferred stock or additional shares of common stock could have the
effect of delaying, deferring or preventing a change in control of PathoGenesis.
The shareholder rights plan also may have the effect of discouraging a change in
control. Further, the company has not opted out of the provision under Delaware
law that imposes certain restrictions on any business combination between the
company and an "interested stockholder" as defined in the Delaware statute.
4
